China's Economic Woes Embolden Calls for Deeper Reforms

When Gabon's General Brice Oligui Nguema ousted his distant cousin last month, he became the eighth military leader who has taken power by force in Africa since 2020. But one aspect about the country was different: it had sold a sizeable amount of bonds on international capital markets, and had just weeks prior sealed continental Africa's first debt-for-nature swap.

The putsch not only sent Gabon's bonds tumbling 10%, but also hit those issued by a number of other countries including neighbouring Cameroon, as jittery investors scanned for who might be next.

The apparent coup trend is adding to other major concerns deterring many investors from Africa - a wave of debt crises, tense geopolitics and an extreme vulnerability to climate change.

"Nearly all markets in that region are paying some price in terms of rising cost of debt," said Sergey Dergachev, portfolio manager at Union Investment.

A UNDP study dated July shows how the costs add up. It estimated Guinea's 2008 coup and one in Mali in 2012 wiped a combined $12-$13.5 billion off the two countries' economies over a 5-year period. This represented 76% of Guinea's 2008 gross domestic product and almost half of Mali's 2012 GDP, the study calculated.

There have been scores of coups and attempted coups in recent decades including in Thailand, Ecuador, Egypt and Turkey.

Investors in those markets reacted reflexively - sell first, think later.

Gabon's coup not only hurt its bonds, it also ratcheted up the interest rate premium, or 'spread', investors demand to hold bonds in JPMorgan's multi-country "Nexgem" Africa index, a move that has still not fully retraced.

Cameroon has been particularly sensitive. Its bonds have lost more ground than Gabon's since the coup. The country's President Paul Biya has ruled for over 40 years through crackdowns and contested elections and wants his son to take over.

In focus too is Senegal, whose President Macky Sall recently ruled out running for a third term after violent unrest, and Congo Republic which had to quash weekend rumours of an overthrow while President Denis Sassou Nguesso - in power for 38 years - was in New York for the U.N. General Assembly.

"Certainly, there's a lot of eyeballs on this (coup) theme right now," said Eamon Aghdasi, a sovereign analyst at investment firm GMO, who co-authored a recent paper on whether democracy matters to debt investors.

"As a bondholder, the worst-case scenario is that a new government comes in and repudiates the previous government's debt".

There is no sign of Gabon's new leaders repudiating debt, though payments on bonds have run into trouble elsewhere, such as Niger.

Credit ratings usually suffer too. Fitch and Moody's have put Gabon on a downgrade warning since the Aug. 30 overthrow. Agencies slashed ratings for Burkina Faso, Mali and Niger, although further afield, Thailand's never budged despite two coups in the last two decades.

"Coups, in general, in Africa or anywhere else, can cause problems for debt repayment partly because of the potential for sanctions," S&P Global analyst Ravi Bhatia said, adding that vital international support can also get shelved.

Gabon, where the Bongo family had ruled for nearly 60 years amid stark inequality, has yet to face the kinds of sanctions imposed on Mali, Guinea, Burkina Faso and Niger - although its International Monetary Fund programme was already off track.

Moody's cited the rise in oil prices in its decision to hold off on a full downgrade, as well as Gabon's membership of the Central African monetary union (CFA franc), which shields it from currency volatility.

The country's bond spreads have eased somewhat since investors' initial panic and could recover entirely, some analysts say, if it makes its first post-coup bond payment on time next month.

"You may get a situation where bondholders might say, if it's a change away from long-term single leaderships, then it may well be a turn for the better," said Simon Quijano-Evans, chief economist with Gemcorp. "As long as elections and democracy come back".

Broadly though, concerns about sovereign stability across Africa loom large. This year's "Fragile States Index" published by non-profit The Fund for Peace rated 46 African countries as at least somewhat unstable.

Even in Kenya, a solid democracy on the other side of the continent, investors warn that general risk aversion could push up the cost of issuing a new bond.

In Japan, we think solid consumption and service activity will likely support inflation staying above the 3% range. We believe that core inflation excluding fresh food and energy is expected to accelerate further in September with private service prices rising.

Meanwhile, thanks to strong activity in services, the jobless rate is expected to edge down in August. Industrial production in Japan will also likely rebound from the previous month's decline mainly due to a pick-up in motor vehicle production.

We think both consumer and business sentiment indices in Korea could deteriorate. Business confidence should weaken on the back of sluggish exports and growing uncertainty in the near-term economic outlook. For consumers, weak domestic equity performance and the recent tightening of mortgage measures might have hurt sentiment.

Singapore reports August inflation next week. We expect headline inflation to dip to 3.9% year-on-year, down from 4.1%YoY from the previous month. Favourable base effects and softer growth momentum will likely translate to a dip in CPI inflation. Core inflation will likely be flat at 3.8%YoY.

Meanwhile, industrial production will likely still be in the red. We could see the tenth consecutive month of contraction for industrial production, tracking the sustained weakness of non-oil domestic exports (NODX). NODX recently posted another month of contraction as global trade grinds lower. Industrial production should stay challenged for as long as NODX is in contraction, with weaker industrial activity seen to weigh on GDP growth.

China is building two-thirds of the coal-fired electricity generation capacity currently under construction globally, and this may not be as disastrous for the climate as it sounds.

The world's largest producer and importer of coal has 136.24 gigawatts (GW) of coal-fired generation under construction, according to data released in July by the Global Energy Monitor.

This represents 66.7% of the global total of 204.15 GW, and China is streets ahead of second-placed India, with 31.6 GW being built and third-placed Indonesia with 14.5 GW.

These three countries represent 89% of the coal-fired plants currently under construction, and it's not a coincidence that all of them have large populations, growing energy demand and vast domestic coal reserves.

China's under-construction coal generation is about 12% of its existing capacity, and adding more coal-fired power would seem incompatible with the stated goal of achieving net-zero carbon emissions by 2060.

But it's worth looking at China's overall energy demand, including its status as the world's largest importer of crude oil.

The large coal-fired construction programme can be seen in the wider context of China's rapid shift to electric vehicles and away from internal combustion engine (ICE) cars and trucks.

Sales of what China terms new energy vehicles (NEVs), which includes fully electric vehicles and types of hybrids, are surging, and accounted for 36.9% of total sales in August, according to data from the China Passenger Car Association.

A total of 1.94 million passenger vehicles were sold in China in August, the strongest month so far this year, with NEVs accounting for 716,000 of the sales.

Sales of NEVs have accelerated from under 5% of the total in January 2021, as car makers scaled up production, resulting in lower costs and improved availability.

It's likely that China will continue to push ahead with the rapid switch to NEVs, given its leadership in mass producing these vehicles and the batteries that power them.

There is also an economic reason for China to encourage the switch to vehicles powered by electricity as it lessens the reliance on imported crude oil.

China's imports of crude in the first eight months of 2023 were 11.4 million barrels per day (bpd), which if paid for at the current oil price would cost in the region of $250 billion.

It makes sense for China to cut its crude imports over time, as this lowers its import bill and reduces its energy reliance on countries such as Saudi Arabia and Russia, which have acted against China's economic interest by tightening oil supply to drive prices higher.

It makes sense from an economic and geopolitical perspective to power China's vehicle fleet using domestic electricity rather than imported crude oil.

The question is then whether China can meet its climate goals by switching increasingly to NEVs, which will be powered by a coal-heavy electricity grid for decades to come.

China used coal for about 63% of its electricity generation in 2022, with hydropower coming in second at 14%, and other renewable energies such as wind generating 9% and solar 5%.

China is also the world's biggest installer of renewable power sources and is expanding its nuclear fleet as well, but coal is expected to remain the bedrock of electricity production, even as its share of generation gradually decreases.

But even using a predominantly coal-fired grid to charge NEVs is better from a climate perspective, insofar as an electric vehicle powered by a 60% coal-fired grid will produce lower lifecycle emissions that a similar ICE vehicle.

A model developed by the U.S. Department of Energy's Argonne National Laboratory shows that in a country with China's power generation profile, a battery electric vehicle will have to drive 78,700 miles (125,900 km) before being cleaner than an ICE equivalent.

However, the average car will drive about 170,000 miles in its lifespan, meaning that the electric vehicle ends up being better for emissions than the ICE equivalent, even if powered by a predominantly coal-fired grid.

While it would obviously be better for the environment for China to stop building coal-fired power plants and instead accelerate the deployment of renewables, there is some logic to the current policy.

Using mainly domestic coal and some relatively low-cost imports will allow China to lower crude oil imports over time, increase the penetration of NEVs and have a lower emissions profile than if it carried on with a predominantly ICE vehicle fleet.

Indonesia's elections next year are likely to spur deforestation as politicians seek campaign funds from businesses in return for easier access to rich natural resources, environmentalists say.

The Southeast Asian nation, the world's third-largest democracy, will hold a general election on Feb. 14, with regional polls planned for later in 2024.

"Next year's election is pivotal for Indonesia to determine the fate of the richest and most biodiverse forests in the world," said Annisa Rahmawati, a board member at Indonesian conservation group Satya Bumi.

She and other experts fear the soaring costs of campaigns - and little oversight of spending - will undercut rainforest protection.

Ward Berenschot, a professor in comparative political anthropology at the University of Amsterdam, said election campaigns in Indonesia are so expensive that politicians from local to national levels have developed "very close ties" with natural resource companies to help finance their ambitions.

"Measures to protect forests have been under pressure because helping campaign donors, or sometimes even family companies, to sidestep or circumvent (them) has been a way to fund campaigns," said Berenschot, who has researched the issue.

Nature-rich Indonesia has a third of the world's rainforests but large areas have been cleared in recent decades due to the expansion of crops like palm oil, as well as mining, pulp and paper expansion, and urbanisation.

Trees suck up planet-warming carbon dioxide to grow, but release it when they rot or are burned. Land use change, mainly deforestation, accounts for about 10-20% of global greenhouse gas emissions.

Indonesia's deforestation rates have slowed in recent years - helped by stricter policies and forest fire controls - but the Southeast Asian nation was still ranked fourth globally for primary tropical forest loss in 2022 by the nonprofit World Resources Institute.

Vote-buying has become common in Indonesia's national elections over the last 25 years, despite crackdowns by the state corruption watchdog. A 2017 poll estimated that a third of voters are impacted by the practice.

After the presidential election in 2019, runner-up Prabowo Subianto - now the defence minister - initially refused to accept the result, with his party citing fraud that included vote-buying. The Constitutional Court dismissed his objections.

With current President Joko Widodo's second and final term due to end, candidates for next year's presidential elections include Prabowo, Central Java governor Ganjar Pranowo and former Jakarta governor Anies Baswedan.

Key voter issues include jobs, the economy, health care access, the cost of living, corruption, pollution and climate change.

Conservationists will be hopeful that Widodo's successor will build on the results his government has achieved in tackling deforestation and restoring mangroves, including making permanent a moratorium on primary forest clearing.

With a growing population of 270 million, Indonesia's elections are becoming increasingly expensive - leading to forests being used as an "ATM" cash dispenser by many parties seeking campaign finance, said Rahmawati of Satya Bumi.

This practice should stop "because it humiliates and ruins our progress in democracy ... destroying our environment and our economy", she said, adding that electoral candidates should be forced to publish the source of all their campaign funds.

Marcus Colchester, a senior policy advisor at the UK-based Forest Peoples Programme, said Indonesian politicians are often unwilling to regulate corporations because they depend on them for funds.

Those links often harm local and Indigenous peoples, whose land is sometimes granted to companies without their consent, he added.

"(The) double whammy - impunity and graft - becomes the main obstacle to social justice and environmental prudence," Colchester said. "Accountability and democracy are undermined, and natural resource governance made impossible."

Berenschot at the University of Amsterdam said changes to legislation have often favoured big business. A 2023 decree seeking to boost jobs and investment, for instance, was criticised by green groups as weakening environmental protections.

"That close connection between business and politics also enabled certain policies and laws ... to be adopted, which risks accelerating deforestation," Berenschot said.

In addition, Indonesia's major political parties are often led by wealthy individuals and business owners, who may prioritise the economy over issues like the environment.

Politicians' campaign spending is hard to track and often lacks transparency.

Ten years ago, an expert survey among 500 local political observers found that a successful candidate for district head spent on average $1.5 million on campaigning, while an elected governor spent about $10 million, he added.

"For an economy where the minimum wage is about $300 per month, these are very big amounts of money," Berenschot noted.

In election years, deforestation rates have slowed but then usually increased the following year, said Toerris Jaeger, director of the Oslo-based NGO Rainforest Foundation Norway.

"In the past we have seen that before the end of a government period, licences and permits in the forest and peatland area were being given to companies that provided or backed up campaign funding or that were tied into political parties that are running in the election," said Jaeger.

Failure to tackle the link between elections and deforestation will make it harder for Indonesia to reach its own climate goals related to reducing emissions from deforestation - and lead to more frequent natural disasters, he added.

"Transparency and accountability are necessary to break the link between deforestation and funding for political campaigns," Jaeger said.

JPMorgan will include Indian government bonds in its Government Bond Index-Emerging Markets (GBI-EM) from June 2024, the Wall Street bank said on Friday.

The inclusion, a first for the country, could lead to billions of dollars of inflows into local currency-denominated government debt and bring down bond yields, while also providing some support for the rupee.

However, there is little direct impact expected on the equity markets.

The Indian government began discussing the inclusion of its securities in global indexes as far back as 2013. However, its restrictions on foreign investments in domestic debt held that back.

In April 2020, the Reserve Bank of India introduced a clutch of securities that were exempt from any foreign investment restrictions under a "fully accessible route" (FAR), making them eligible for inclusion in global indexes.

Currently, 23 Indian Government Bonds (IGBs) with a combined notional value of $330 billion are index eligible, JPMorgan said.

About 73% of benchmarked investors voted in favour of India's inclusion, it said.

JPMorgan said Indian bonds will eventually hold a weight of 10% in its index, following 1% additions to its weightage each month from next June.

The inclusion could result in inflows of close to $24 billion over this 10-month period, analysts estimate.

This is significantly higher than the $3.5 billion invested by foreign investors in Indian debt so far this calendar year.

Foreign holdings of outstanding bonds could rise to 3.4% by April-May 2025, from 1.7% currently, analysts estimate.

India's fiscal deficit remains high at a targeted 5.9% of GDP for the year ending March 31, 2024, which will result in the government borrowing a record 15 trillion rupees (about $181 billion).

So far, banks, insurance companies and mutual funds have been the largest buyers of government debt. An additional source of funds will help cap bond yields and the government's borrowing costs.

Traders estimate the benchmark bond yield will fall 10-15 basis points to 7% over the next few months.

Corporate borrowers will also benefit as their borrowing costs are benchmarked to government bonds.

However, increased foreign flows will also make the bond and currency markets more volatile and could push the government and central bank to intervene more actively.

Larger debt inflows from next financial year will make it easier for India to finance its current account deficit and reduce the pressure on the rupee.

Index inclusion-related inflows of close to $24 billion will cover a material part of India's $81 billion current account deficit, estimated for next financial by IDFC First Bank.

($1 = 82.8510 Indian rupees)

Key insights from the week that was.]

The September RBA meeting minutes presented a detailed account of the Board's deliberations and their assessment of risks. In recent months, the Board has stopped describing its considerations for policy – the choice between remaining on hold and a rate hike – as "finely balanced". Rather, it has become increasingly clear that the Board view the case for remaining on hold as the "stronger" argument, in step with their growing confidence in navigating a soft landing. While the Board still conclude that "some further tightening in policy may be required should inflation prove more persistent than expected", the hurdle for the Q3 CPI report or interim Monthly CPI Indicators to raise alarm is high. Westpac remains of the view that the RBA will remain on hold until August 2024 when we see the next rate cutting cycle begin, to restore balance to demand conditions and support growth's return towards trend.

The Q3 Westpac-ACCI Survey of Industrial Trends demonstrated that the RBA's rapid tightening cycle is having a material impact on Australian industry. At 51.3, the Westpac-ACCI Actual Composite signals conditions are approaching stall speed. Indeed, that new orders growth held flat for a second consecutive quarter and is now the number one concern of manufacturers is consistent with the marked slowing of the Australian economy. Within this context, firms report there is little incentive to grow their workforce or lift their investment intentions despite an easing in labour and material shortages. Overall, the tone of the survey remains broadly downbeat, with expectations for future activity in the sector subdued – adding to the case for the RBA to remain on hold.

Central bank meetings dominated the news offshore.

The FOMC kept the fed funds rate at 5.375%; however, the dot plot suggests most members expect the data to justify one last hike before the end of the year. During Q&A, Chair Jerome Powell said 'we need to see more progress' when speaking to why they felt a further hike could be on the cards. On balance, the FOMC expects the upside surprise to growth currently being experienced in 2023 to persist into 2024, the GDP forecast for next year revised up from 1.1% to 1.5%. The unemployment rate is also only expected to lift at the margin from now to end-2024, from 3.8% to 4.1%, while PCE inflation is expected to only slowly trend down to 2.5% at end-2024. Consequently, the FOMC now expects only 50bps of cuts in 2024 from 5.625% at end-2023.

While they do anticipate a further reduction in inflation and the fed funds rate in 2025 and 2026, it is again expected to be slow going and still leaves the fed funds rate above their longer run estimate of neutral, 2.5%. We see the U.S. economy disappointing the FOMC's expectations in coming months and so anticipate an earlier and larger start to the cutting cycle, pencilling in 100bps of rate cuts in 2024 versus the FOMC's 50bps. However, we also perceive greater inflation risks in the out years and so, at 3.375%, our end-2025 fed funds forecast is also materially above the FOMC's 2.5% 'longer run' figure. In our view, these inflation risks are likely to primarily be structural rather than cyclical, limiting the effectiveness of policy and, at the margin, creating greater risk for activity growth and the labour market. Highlighting this, through 2025, we see the unemployment rate holding around 5.0% and GDP growth remaining below trend.

Overnight, the Bank of England paused for the first time since they started hiking in 2021 in a divided vote — five voted to remain on hold, while four voted to hike. The pause came as a surprise to economists, but market pricing had drawn much closer to the final result after the last CPI release. In August, annual inflation growth fell to 6.7%yr as the monthly gain only partially made up for July's fall, bringing the three-month average to flat. The contribution from services nudged down to 3.2% — just under half of total CPI. Goods also decelerated further, much to the surprise of the BoE. August was the second month that headline CPI undershot the BoE's forecast of 6.93% for Q3 (July's print was an undershoot at the second decimal place). Higher fuel costs have been observed in inflation prints in U.S. and Europe, but they did not add as much pressure to the headline print for the UK in monthly terms and were a dampening influence in the annual print. Reports suggest this may be a result of a more delayed response to the spike in oil prices. Overall, the percentage of the CPI basket running above the BoE's 2% target has trickled down to 81% over July and August.

In addition to the weaker-than-expected CPI, the Committee was concerned about the growth outlook following a 0.5%mth decline in GDP in July. This followed other indicators which suggest weaker growth can be expected in the near term. Strong wages growth had seen economists anticipate further hikes. However, while the Average Weekly Earnings figures continue to overshoot the Bank's forecasts, they were characterised as "difficult to reconcile with other indicators of pay growth". The Decision Maker Panel data, frequently referenced by Governor Andrew Bailey, suggests wages growth has been stable at 5%. As such, the Committee will be looking at broader measures of wages ahead.

The statement noted that the current stance was "restrictive" and that "Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures". Before the November meeting, we will get two CPI prints and another wages read which may allay or fuel the hawks' fears. Hawk Sir Jon Cunliffe will also be leaving and BoE internal Sarah Breeden arriving. Breeden has said she will have a more 'balanced' approach to monetary policy.

Across the Tasman, New Zealand's Q2 GDP rose 0.9%qtr, materially above the market's and RBNZ's expectation but in line with our New Zealand team's view. The technical recession through December and March quarters was also revised away and puts the economy 0.5% larger than the RBNZ expected in August. Given the revisions and Q2 GDP print, we continue to expect the RBNZ to hike once more by year end. The market is also coming to this view, although it is currently priced for this last hike to occur in early-2024.