perspectives politics and the markets march 2008 hot commodities: policies keep
demand simmering. BY ROBERT JOHNSTON. DIRECTOR, GLOBAL ENERGY ...
perspectives INSIGHTS FROM EURASIA GROUP
politics and the markets MARCH 2008
Hot Commodities: Policies Keep Demand Simmering b y Ro b e rt J o h n s to n D i r e c to r, G lo b a l E n e rg y a n d N at u r a l R e s o u rc e s
C Global Political Risk Index The GPRI, which is produced by Eurasia Group, measures a country’s ability to absorb political shocks. The higher the number, the more stable the country. HUNGARY 77 SOUTH KOREA 76 POLAND 74 BULGARIA 70 MEXICO 67 CHINA 66 ARGENTINA 65 BRAZIL 65 SOUTH AFRICA 65 TURKEY 64 RUSSIA 63 INDIA 62 THAILAND 62 EGYPT 60 ALGERIA 59 COLOMBIA 58 UKRAINE 58 SAUDI ARABIA 57 INDONESIA 56 PHILIPPINES 54 VENEZUELA 51 IRAN 50 NIGERIA 46 PAKISTAN 42
Courtesy of Citi Private Bank
government society security economy
ommodities markets showed surprising resilience in February, thanks to monetarypolicy easing in the US and a few glimmers of hopeful economic news. In the months ahead, political factors—notably the influence of Organization of Petroleum Exporting Countries, China’s fiscal and monetary policies and government support for biofuels—will help sustain demand for oil, metals and agricultural products. Even if a global economic slowdown reduces oil demand, OPEC would be willing to hold prices up by reducing production. Meanwhile, Beijing is not expected to tighten its expansionary economic policies ahead of the Olympics, helping support base metal prices. In terms of OPEC and major non-OPEC producers, oil prices are highly inelastic. US oil-demand forecasts generally are showing expected growth of just 1% for 2008, and many analysts predict economic contraction. But this picture is offset by strong growth outside Organization for Economic Cooperation and Development (or OECD) countries, for which the International Energy Agency forecasts 4% growth for 2008. If US consumer demand falters, OPEC is likely to cut production to prevent a significant inventory buildup. Non-OECD demand benefits from a stronger economic picture and the policy choice of governments in China, India and the Persian Gulf to insulate their consumers and industry from market costs via fuel subsidies. A similar subsidy framework does not exist in the base metals markets, where prices tend to be more elastic to a slowing economy. The metals market showed indications of elasticity in the second half of 2007 and early 2008. Nickel, particularly sensitive to the cyclical outlook for the Chinese-dominated stainless-steel (continued on inside cover)
(continued from cover)
industry, has sold off sharply since the first quarter of 2007, but prices have recently firmed up. Producers of these metals include Mexico, Russia, the Philippines and Brazil. If the recent firming up of metals prices persists, these countries probably will continue enjoying the positive economic effects of a strong commodity market. The most significant policy-related risk to the metals outlook is the possibility, though unlikely, that Chinese authorities will elect to pursue further tightening measures in an attempt to slow inflation, which reached a 10-year high in January 2008. Finally, non-OECD economic growth (especially in China and India) and government support for biofuels will continue to bolster agricultural prices, creating a windfall for certain countries, including Argentina, Ukraine and Brazil. These states are significant producers of wheat and soybeans, and they have benefited from a two-year rally in which global prices have doubled. Of course, there is a negative side: Higher food costs are creating inflationary pressures for major food importers such as China. Two key factors causing the price rally in agricultural commodities are the growing wealth across the non-OECD markets and the competition for acres against biofuels crops such as corn and sugar. Neither factor is likely to weaken in 2008. Betting against the commodity supercycle has been a costly proposition in recent years, especially considering the market’s strength in the face of global credit worries and a possible US recession. Political drivers are on track to continue supporting virtually all classes of commodities, particularly in energy and agriculture. Although the oil market lacks a single catastrophic risk to worry about, increased OPEC influence, inelastic demand and slow supply growth increasingly look like the norm. This bullish picture for oil boosts biofuels as an alternative, suggesting the possibility of government intervention in food markets to address high prices. 2 politics and the markets
CLOSE-UP: China-Japan Diplomacy Tests Its Sea Legs
b y K y l e J a ro s a n d Ro s s S c h a a p
Political relations between China and Japan have improved more slowly in recent years than the two countries’ booming economic ties—but an important diplomatic hurdle may soon be cleared. Recent com(China) ments from China’s ambassador to Japan, as well as rating forecast Japanese press reports, suggest that Beijing and Tokyo are close to an agreement on jointly developing disputed gas fields in the East China Sea. Although officials challenge reports about an imminent settlement, both governments have shown greater optimism about resolving the ECS dispute, and they may want to achieve a breakthrough before Chinese President Hu Jintao’s planned spring visit to Japan. Although 12 rounds of talks between China and Japan, which began in 2004, have failed so far to end the ECS clash, evolving domestic political dynamics The Japanese flag flies in front of Beijing’s Great Hall might support a solution in the near term. Beijing of the People and Tokyo both are eager to consolidate ongoing rapprochement with tangible progress on the ECS, which could allay a key flashpoint in bilateral relations. In China, President Hu and Premier Wen Jiabao are more confident after last fall’s 17th Party Congress, and senior bureaucrats may hope to score diplomatic points ahead of the Beijing Olympics. In Japan, Prime Minister Yasuo Fukuda, who is more accommodating toward Beijing than his predecessors, is under pressure from domestic rivals. Chinese leaders worry that, unless Fukuda can buoy his popularity with a diplomatic success, they may soon be dealing with a more hawkish successor. A deal between China and Japan that defers resolution of intractable territorial questions in favor of short-term technical cooperation may work. However, reaching consensus on key details like compensation for ECS resource-development costs and division of profits will be politically sensitive—and failure to do so soon could cause China and Japan to miss the opportunity.
stability Spotlight
66
Total China-Japan Trade in Goods (excluding Hong Kong) Tense relations during the 2001 through 2006 tenure of Japanese Prime Minister Junichiro Koizumi did not disrupt growth in bilateral trade. $250 (in billions) 200 150 100 50 0
2001
2002
2003
2004
Data Source: Ministry of Commerce, People’s Republic of China
2005
2006
2007
Inside the Index In the following briefs, Eurasia Group analysts highlight the connections between stability and key political issues in important emerging markets.
LEGEND
HUNGARY
government
TURKEY
society security
pakistan
economy
Thailand
Hungary GPRI
77
Leadership turmoil rattles markets
Though Prime Minister Ferenc Gyurcsány is unlikely to leave office this year, such an event would rattle markets—which correctly perceive that he is the person behind ongoing successful fiscal reform. A March 9 oppositionsponsored referendum, which could swing against him, asks voters: Do you support the abolition of new hospital and doctorvisit fees, as well as the required university-tuition contributions? If more than half of voters participate, a “yes” vote may be interpreted as an opposition victory. The ruling Hungarian Socialist Party, which is struggling in the polls, might shake up their leadership, pushing Gyurcsány out before the end of 2008 and undermining macroeconomic stability.
Pakistan GPRI
42
Opposition win eases social tension
The opposition’s landslide victory in the Feb. 18 general election will lead to broad-based political bar-
Legend:
Positive change
Negative change
SOUTH AFRICA
gaining over a coalition government and a return to the civilian politics of the 1990s. The Pakistan People’s Party, which is likely to keep its options open in terms of coalition partners, will lead the government. The recent election result is a major political defeat for weakened President Pervez Musharraf and will ease social tension—at least temporarily.
South Africa GPRI
65
Power cuts undermine economic growth
Electricity-supply shortages, which are likely to continue for at least another four years, will undermine economicgrowth forecasts and business confidence in South Africa. Major mining and metals companies will receive only 90% of their required electricity until 2012, but all sectors will be affected by the crisis. Various problems have contributed to the recent
power cuts, but the supply crunch is mainly due to poor planning, regulatory issues and inadequate management by Eskom and the government. There is no quick-fix solution and, given rising demand heading into winter, further outages can be expected.
Thailand GPRI
62
A Sense of normalcy returns
Near-term stability will be shored up by the military’s weakness as former Prime Minister Thaksin Shinawatra returns. If the next few months pass without a major confrontation between the new government and the military, a sense of normalcy—unreliable as it may be—likely will return to the country. It would take several miscalculations by the new government to incite the public, but such an occurrence would raise the threat of the military again intervening.
Turkey GPRI
64
Headscarf BAN FACES COURT challenge
The headscarf issue likely will continue to dominate Turkey’s political agenda in coming months. Recently, the main opposition, the Republican People’s Party (or CHP), decided to challenge before the constitutional court a reform package aimed at easing the headscarf ban. According to CHP, the governmentsponsored constitutional amendments approved by parliament on Feb. 6 and Feb. 9 violated the principle of secularism enshrined in the constitution as a defining characteristic of the Turkish republic. Given that other reforms have stalled, this legal tussle could increase Turkey’s vulnerability to potential external shocks.
No change
p o l i t i cs a n d t h e m a r k e ts 3
The Outlook Key issues and possible outcomes for the coming month. country
GPRI *
outlook
what to watch for
Algeria
59
President Bouteflika’s bid to change the Algerian constitution will succeed, allowing him a third presidential term.
Argentina
65
Labor unions are likely to obtain real-wage increases as annual negotiations intensify, heightening inflation concerns.
Brazil
65
Energy supply remains tight, despite a low risk of power rationings.
Bulgaria
70
Fiscal-policy challenges could test the government and exacerbate strains within the coalition.
China
66
The new economic-policy team appointed at the March National People’s Congress will be better equipped to promote reforms.
Colombia
58
President Uribe’s supporters are pushing for a referendum that would allow him to run for a third term in 2010. The Gaza situation will increase cross-border tension and strain Egypt-Israel relations in the short term.
Egypt
60
Hungary
77
A referendum on health care insurance will weaken the prime minister and challenge reforms, but government collapse is unlikely.
India
62
The government’s budget will be stretched by the roll out of its national rural-employment-guarantee scheme.
Indonesia
56
Inflation will continue to affect consumers, eroding President Yudhoyono’s popularity and making reform difficult.
Iran
50
The disqualification of reformist candidates ahead of the March parliamentary election exacerbates internal tension.
Mexico
67
An internal election in the leftist PRD will likely spawn a moderate leadership.
Nigeria
46
Pakistan
42
Philippines
54
President Arroyo may survive the recent scandal, but she will be politically battered and on the defensive for months.
Poland
74
Central-bank resignations and declining research quality are unlikely to harm monetary policy—but both pose long-term risks. Medvedev will win the March 2 presidential election and clarify his plans to attract more foreign investment.
President Yar’Adua seeks to lessen the scope of former President Obasanjo’s corporate influence.
The opposition’s Feb. 18 election victory eases social tension, but intense political bargaining lies ahead.
Russia
63
Saudi Arabia
57
Wahhabi clerics’ opposition to reforms will likely slow King Abdullah’s attempts to open the local stock market to foreign investors.
South Africa
65
An attempt to dissolve independent organized-crime-fighting units highlights ANC divisions and concerns over corruption.
South Korea
76
The probusiness Grand National Party will gain momentum leading up to the April 9 parliamentary election and is likely to win a majority.
Thailand
62
Confidence in near-term stability improves with former Prime Minister Thaksin’s anticlimactic return.
Turkey
64
Political tension intensifies due to the headscarf issue.
Ukraine
58
The opposition Regions of Ukraine party is likely to support WTO entry but fight the government’s NATO-membership efforts.
Venezuela
51
The state oil company PDVSA will continue to defend itself against court injunctions to freeze its assets overseas.
Legend: Positive outlook Negative outlook Neutral outlook *The GPRI, which is produced by Eurasia Group, measures a country’s ability to absorb political shocks. The higher the number, the more stable the country.
Citi Private Bank has retained Eurasia Group to offer political analysis and insight. The opinions expressed in this report are solely those of Eurasia Group and do not necessarily reflect the opinions of Citi Private Bank or other business units of Citigroup Inc. Eurasia Group developed the first qualitative comparative political-and-economic-stability index, which Citi Private Bank has licensed, called the Global Political Risk Index, or GPRI. The index is designed to measure a country’s ability to absorb external or internal political shocks. Although the timing of such events cannot be predicted, the GPRI is meant to gauge how well particular nations would be able to withstand them. All expressions of opinion are subject to change without notice and are not intended to be a guarantee of future events. This document is for information only and does not constitute a solicitation to buy or sell securities. Opinions expressed herein may differ from the opinions expressed by other businesses of Citigroup Inc. Although information in this document has been obtained from sources believed to be reliable, Citigroup Inc. and its affiliates do not warrant its accuracy or completeness and accept no liability for any direct or consequential losses arising from its use. Past performance is no guarantee of future results. Throughout this publication where charts indicate that a third party (parties) is the source, please note that the source references the raw data received from such parties. The charts are designed by Citi Private Bank. Investors cannot invest directly in an index. Citi Private Bank is a business of Citigroup Inc. (“Citigroup”), which provides its clients access to a broad array of products and services available through bank and nonbank affiliates of Citigroup Inc. Not all products and services are provided by all affiliates or are available at all locations. In the US, brokerage products and services are provided by Citigroup Global Markets Inc. (“CGMI”), member SIPC. CGMI and Citibank, N.A. are affiliated companies under the common control of Citigroup Inc. Outside the US, brokerage services may be provided by other Citigroup Inc. affiliates. Citi and Citi with Arc Design are trademarks and service marks of Citigroup Inc. and its affiliates and are used and registered throughout the world. In the UK, certain services are available through Citibank, N.A. (“Citibank”) and Citibank International PLC, 33 Canada Square, Canary Wharf, London E14 5LB, which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the UK and is a subsidiary of Citigroup Inc., USA. There are additional risks associated with international investments, including foreign political, currency and economic factors to consider.
Investment Products: Not FDIC Insured • No Bank Guarantee • May Lose Value Copyright 2008, Citigroup Inc. All rights reserved.
(1869)
