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Rate expectations: developing economies threatened by US inflation

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As policymakers across the developing world battle the persistent spread of coronavirus, they also face the economic threat of inflation — and not just at home.

Escalating price growth in major economies, in particular the US, is fuelling investors’ expectations of rate rises. That pushes up bond yields, making it more expensive for other countries to sell debt as buyers demand higher returns.

What should be good news — the beginning of a global recovery — has instead become a threat: that the cost of borrowing will hit dangerously high levels in countries such as South Africa and Brazil, throwing their already precarious public finances into disarray.

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DAY 4: How the virus disrupted official inflation statistics.

DAY 5: Why rising prices in advanced economies are a problem for indebted developing countries.

“Emerging economies should be worrying more about US inflation than about their own,” said Tatiana Lysenko, lead economist for emerging markets at S&P Global Ratings.

It is not just that inflation and rising yields in the US push up borrowing costs in the developing world, she said. The broader risk is that the US economy will power ahead of emerging economies, causing outflows from their stocks and bonds and, eventually, currency weakness.

While rich countries have been able to borrow during the pandemic at very low rates, many developing countries already face a much higher cost of finance.

Data from S&P show that refinancing costs for 15 of the 18 largest developed economies have fallen below their average cost of borrowing by more than a percentage point. Most are paying a fraction of 1 per cent. A 1 percentage point rise in financing costs would be easy for most to bear.

The same cannot be said of developing countries. Egypt, which must refinance debt equal to 38 per cent of gross domestic product this year, is paying an average rate of 12.1 per cent, above its average cost of 11.8 per cent, according to S&P. Ghana is paying 15 per cent, compared with an average of 11.5 per cent.

The danger lies not only in very high rates. Brazil has refinanced at an average rate of 4.7 per cent this year, lower than the average cost of its existing debt. But it did so by selling bonds that must be repaid more quickly than in the past.

This unpicks the work of years in which Brazil sold longer-dated and fixed rate debt to make its finances more sustainable. Last year the average maturity of its new debt was two years, down from five in 2019.

Brazil needs to refinance debt equal to 13 per cent of GDP this year — a lower proportion than smaller nations, but a greater sum in total, and it could be scuppered by rising rates or a slower-than-expected recovery.

Its central bank has already raised rates twice this year in an effort to quell price pressures after inflation overshot its target range of 2.25 to 5.25 per cent. Another rise is likely at its next meeting later this month, and it forecasts a base rate of 5.5 per cent by year-end, up from a record low of 2 per cent in March.

Bar chart of % showing Central banks may have no option but to raise rates

Brazil is a clear example of how inflation and rising yields are a threat to debt sustainability, said William Jackson of Capital Economics. “It has stretched public finances, rising inflation and a central bank that is raising rates, feeding into debt service costs.”

South Africa is in the same category, he said, along with Egypt and others with large refinancing needs.

There are mitigating factors. For example Brazil, South Africa and India all rely much more on domestic lenders than on foreign ones. That makes them less vulnerable to capital outflows than they were during the debt crises of the late 20th century.

India in particular has turned to its domestic banking system to issue benchmark 10-year bonds at rates capped at about 6 per cent. It too has borrowed at shorter maturities during the pandemic, although its low refinancing requirement this year — equal to just 3.3 per cent of GDP — makes it less vulnerable to rising rates.

But William Foster, vice-president in the sovereign risk group at Moody’s Investors Service, said that India’s fiscal problems leave it dependent on debt rather than government revenues to finance its pandemic response.

Bar chart of Average refinancing rate (2021 year to date, %) showing Financing costs rise

“India runs large fiscal deficits and has a very high debt stock,” he said. “The most important thing for debt sustainability is to achieve a higher rate of medium term growth, through reforms and other measures to crowd in the private investment that we haven’t seen for years.”

If, as many policymakers hope, this year’s rise in inflation turns out to be transitory, emerging economies’ interest rates may not have to rise far.

Roberto Campos Neto, governor of Brazil’s central bank, told a conference this week that the issue was whether inflation was temporary and justified by growth, or whether central banks should raise rates further. “The first case is benign for the emerging world,” he said. “The second is not.”

Food and commodity prices are already growing at a pace that is fuelling consumers’ inflation expectations, Lysenko said. If interest rates go up significantly, reducing developing economies’ debt to sustainable levels — and delivering growth — will become much harder.

“In an interconnected world with a lot of capital flows, US yields have significant spillovers,” she said. “It is too early [for emerging markets] to tighten [monetary policy], as to do so now could undermine their recovery. But some countries may not have much space left not to tighten.”



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Hong Kong-Taiwan spat threatens cross-Strait business

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Official representation between Hong Kong and Taiwan is set to end this year as mounting political tensions threaten one of the region’s most important trade and investment relationships.

The number of staff in Taiwan’s representative office in Hong Kong has dwindled over the past two years as the territory has stopped issuing visas, with the documents of those who remain due to expire by the end of November.

Hong Kong also abruptly suspended operations of its representative office in Taipei two weeks ago, ending its official presence there. The stand-off has grown so severe that Taipei has begun making contingency plans for a situation without on-the-ground representation in Hong Kong, two senior Taiwanese government officials said.

The breakdown in relations follows rising military tensions between Taiwan and China and a crackdown by Beijing on pro-democracy groups in Hong Kong that has led some activists in the territory to seek refuge in Taipei.

China claims Taiwan as part of its territory and has threatened to annex it if the island fails to submit to its control indefinitely.

Analysts said that cutting official channels would undermine Hong Kong’s traditional role as a conduit for business and financial exchanges between Taiwan and China. Despite the dispute with Beijing over sovereignty, Taiwanese companies are among the largest foreign investors, employers and exporters in mainland China.

Taiwan air force personnel during the visit by President Tsai Ing-Wen
Military tensions between China and Taiwan have escalated, but investment and trade across the Taiwan Strait remains important to both countries © Ritchie B Tongo/EPA-EFE/Shutterstock

A significant part of trade across the Taiwan Strait trade goes through Hong Kong, and many Taiwanese investors in China also use Hong Kong for financial, taxation and legal purposes. Last year, Taiwan was Hong Kong’s second-largest trading partner, while Hong Kong was Taiwan’s fifth-largest, with HK$504bn (US$65bn) in total bilateral trade. Taiwanese companies invested US$912m in Hong Kong in 2020, while Hong Kong-registered companies invested US$555m in Taiwan.

“Hong Kong has been a springboard for Taiwanese companies into mainland China and it has also been a springboard for Chinese [companies] into Taiwan,” said Liu Meng-chun, a research section director at the Chung-Hua Institution for Economic Research, a Taiwanese government-backed think-tank.

Tensions between Hong Kong and Taipei have escalated over the past two years after the territory started demanding Taiwanese diplomats sign documents declaring their country part of China as a precondition for being issued a visa.

After Taipei refused, the number of staff at its office in Hong Kong began to dwindle, from 20 to eight today, according to the Mainland Affairs Council, Taiwan’s cabinet level China policy body.

Hong Kong, meanwhile, said it was temporarily closing its Taipei office because “Taiwan’s series of actions in recent years has severely damaged Hong Kong-Taiwan relations”.

A Hong Kong government official suggested the suspension came on instructions from Beijing.

“I think Beijing is of the opinion that [Taiwan’s representative office] affects national security,” said Sung Yun-wing, an economics professor at the Chinese University of Hong Kong, who is also a member of a semi-official think-tank, the Chinese Association of Hong Kong and Macao Studies, in Beijing.

“There have been reports that Taiwan has been encouraging the protest movement in Hong Kong, which has turned violent, so the protest movement is not only against the Hong Kong government but also Beijing,” said Sung. He added China was also concerned Taiwan was “sheltering” Hong Kong protesters.

While Taipei has been careful to avoid being seen as making it too easy for Hong Kong dissidents to flee to Taiwan, civil society groups in the country have supported the protest movement with advice, money and logistics. “This is something we cannot interfere with as they have done nothing illegal,” said a senior Taiwanese China policy official.

Historically, Hong Kong’s most important economic role in the Taiwan-China trade has been as a sea and air trans-shipment hub for Taiwanese companies to supply their factories in southern China with components.

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While analysts suggested that much of this commerce could continue even if official ties between Taiwan and Hong Kong were severed, they foresaw a sizeable impact on financial services, tourism and education.

“Hong Kong plays a very important role for Taiwanese private wealth management,” said Patrick Chen, head of Taiwan research at CLSA, the brokerage.

He said many Taiwanese individuals had accounts in Hong Kong, where the local units of Taiwan’s banks offered them offshore investment products not accessible under the island’s stricter regulations.

Liu of the Chung-Hua Institution for Economic Research said many Taiwanese enterprises kept profits from their China operations with their Hong Kong affiliates for tax purposes.

“These things would become a lot more cumbersome without official representation because you would have to start sending documents back and forth for notarisation,” Liu said.



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Nato leaders fret China’s Atlantic ambitions

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China’s growing military and economic presence in the Atlantic region is expected to trigger a rare warning from Nato leaders about the potential security threat when they meet on Monday, diplomats said. 

From joint Chinese drills with Russia to western worries that China wants to set up military bases in Africa, the Nato focus reflects China’s primacy among western foreign policy concerns, in particular those of US president Joe Biden.

“This is not about ‘Nato going to China’,” said Claudia Major, a defence analyst at the German Institute for International and Security Affairs. “It’s about ‘China is coming to Europe and we have to do something about it’.”

In 2015, joint military drills with Russia brought the Chinese navy into the Mediterranean and the heart of Europe for the first time. Since then, China has built up the largest naval fleet in the world and invested in critical European infrastructure, including ports and telecoms networks.

“China [through its navy] has come through the Indian Ocean, into the Gulf, up to the Red Sea and they’ve been in the Mediterranean,” according to one British military official, who said China had not yet deployed submarines in the north Atlantic but could do so in future.

“You build nuclear submarines for range and stealth. And China does like to test the boundaries.”

The planned joint statement by the transatlantic security alliance, which diplomats said was still under discussion and subject to change, would be only the second time that Nato leaders have addressed the subject of China head-on. The first was in December 2019, at the insistence of the administration of Donald Trump.

But Biden is understood to be pushing for tougher language than the bland “opportunities and challenges” terminology used that time.

Nonetheless, how to deal with the issue represents a dilemma for the 30-member group, which was originally set up in 1949 to deal with cold war-era threats.

Internally, Nato countries are divided over how to treat China: member Hungary, for one, has good political relations with Beijing.

In addition, there is reluctance to confront Beijing in its own Pacific region — although the UK and France have followed the US in deploying ships to carry out freedom of navigation exercises in the South China Sea.

Chinese and Russian marines take part in joint exercises in China’s Guangdong province
Chinese and Russian marines take part in joint exercises in China’s Guangdong province © Li Jin/Getty

China’s joint military operations with Russia are viewed as a particularly unwelcome development by some Nato members. As well as their annual military exercises, Beijing and Moscow have recently added joint missile defence drills and training for internal security forces.

“Their [the Chinese/Russian] relationship is transactional and pragmatic rather than ideological,” the UK military official said. “But working together in any form provides confidence. And confidence is something we should be wary of.”

As the Center for a New American Security, a bipartisan US think-tank, warned in a January report: “Where Russian and Chinese interests align, Moscow and Beijing could eventually co-ordinate their combined capabilities to challenge US foreign policy.”

Another Nato anxiety is Africa, which China could use to expand its military presence in the Atlantic as part of its long-term goal to become a truly global armed force.

Gen Stephen Townsend, head of US Africa Command, told the US Senate in April that his “number-one global power competition concern” was what he described as Chinese efforts to establish a militarily useful naval facility on Africa’s west coast. “I am talking about a port where they can rearm with munitions and repair naval vessels,” he said.

Experts on the Chinese military said there was no evidence that Beijing was trying to establish such a west African base, yet. However, China has a base in Djibouti and has already used international anti-piracy missions in the Gulf of Aden to train thousands of military personnel and to build military relations with countries outside its usual neighbourhood.

Each time a naval contingent finishes deployment, for example, it typically takes a detour on the way home. Some have visited the Mediterranean and the east and west coasts of Africa.

Another trend vexing Nato allies is the growing involvement of Chinese companies in critical infrastructure in Europe, such as through telecommunications company Huawei.

Chinese state shipping company Cosco also owns a controlling stake in Piraeus, Greece’s largest port, and is reportedly in talks to invest in a Hamburg port terminal.

Such economic ties complicate Nato’s efforts to create a unified approach on China — as do the political relationships between Beijing and friendly European leaders.

That creates the potential for clashes, with the tougher stance of Washington and Jens Stoltenberg, Nato’s secretary-general, who last month warned that China was “coming to us” in areas including cyber space, Africa and the Arctic.

“There is a risk that having this discussion within Nato surfaces very uncomfortable differences between allies on how much China is actually perceived as a threat,” said Sarah Raine, an expert in geopolitics and strategy at the International Institute for Strategic Studies.

“The fact is that there are countries which are seen by hawks as making very pro-China arguments within Nato, at least with regards to being robust but not confrontational.”

Additional reporting by Katrina Manson in Washington



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Sponsors pull out of Copa America in Brazil over Covid risk

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A trio of corporate sponsors — Mastercard, Ambev and Diageo — have pulled their brands from the Copa America football competition in Brazil, which is due to kick off on Sunday in spite of the country’s raging Covid-19 crisis.

Latin America’s largest nation offered to host the regional tournament at the end of last month after previous co-hosts Argentina and Colombia cancelled. Buenos Aires cited an increasing number of coronavirus cases, while Bogotá blamed domestic protests.

Brazil’s decision to step in, which had the backing of rightwing president Jair Bolsonaro, drew censure from many medical figures and opposition politicians, who argued it risked further spreading the virus as the pandemic continues unabated in the country.

Mastercard said after careful analysis it had decided to remove its branding from this year’s Copa America, though it will remain a sponsor of the competition, which was already postponed in 2020.

British alcoholic drinks group Diageo, which owns Smirnoff, Guinness and Johnnie Walker, said it would stop all brand activities “given the current health situation in Brazil and in respect of the timing of the Covid-19 pandemic”.

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“The sponsorship terms were agreed upon when the event was scheduled to be held in Colombia and Argentina,” the company added. “Diageo reiterates its commitment to society, observing safety protocols and institutional actions that contribute to the mitigation of the pandemic.”

Brazilian beer maker Ambev, which is part of the world’s largest brewer AB InBev, said “its brands will not be present at the Copa America”. 

The votes of no confidence come as Brazil faces a potential third wave of Covid-19 infections with the cooler season setting in.

At more than 480,000 lives lost, the country has the second-highest death toll from the respiratory disease after the US. A shortage of jabs has stymied vaccination campaigns.

“We are still in a very serious situation,” said Marcelo Ramos, a researcher in public health at the Fiocruz biomedical institute. “When it was announced that Brazil would host the Copa America, the message was that we are in a calm situation, which does not correspond to reality.” 

However, the country’s health minister this week insisted holding the football competition would not generate any additional risk of contamination, since no fans would be attending matches. 

Bolsonaro has earned international opprobrium for his handling of the pandemic, which has included disparaging the use of masks and talking down the importance of vaccines.

But the former army captain received a boost when the Brazilian department store chain Havan, whose co-founder Luciano Hang is a vociferous supporter of the president, announced it would sponsor the tournament.

“I’m sure it will be a competition that will delight the entire Brazilian population”, he said.

This week Brazil’s supreme court rejected attempts to bar the country from hosting the Copa America. 

The Brazilian Football Confederation and the South American Football Confederation did not respond to requests for comment.



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