The “fifth BRIC” motors along

Indonesia, sometimes known as the “fifth BRIC” (after Brazil Russia India China) because of its population size and growth potential, now has debt rated at investment grade for the first time since the Asian financial crisis:

While a credit-rating cut hangs over some nations, the Southeast Asian giant’s sovereign debt has been bumped back up to investment grade by Fitch Ratings, in December, and Moody’s Investors Service this week. Standard & Poor’s will surely follow suit.

Investors have already rewarded the country for solid fundamentals—foreign direct investment grew 20.2% last year to a record $19.3 billion, the government said Thursday, and, earlier this month, Indonesia sold 30-year bonds at a record-low yield of 5.375%. Meanwhile, gross domestic product growth is trotting along at a healthy 6%-plus, public debt is under control, and inflation is relatively benign at under 6%. Still, there are reasons to be cautious.

Corruption and weak infrastructure are perennial problems. Crumbling roads and inadequate ports especially stifle trade, costing as much as 1% of GDP, according to analysts. A recently enacted land acquisition bill should help. But there is much work to be done.

While India and China gain many more headlines, Indonesia may be both a more attractive bet for investors and a better case study for development professionals trying to find lessons applicable to less developed countries.

How close is the UK to the edge? (updated)

In his autumn statement, George Osborne warned that, without his programme of fiscal consolidation, “Britain would have borrowed an additional hundred billion pounds in total [by 2014/15]. If we had pursued that path, we would now be in the centre of the sovereign debt storm.”

But how confident can we be that that storm has been averted? In the city, sovereign risk and an economic downturn are seen as the most important threats to the UK financial system. An economic downturn now seems more than likely, and will be savage if efforts fail to shore up the euro.

What about a sovereign debt crisis in the UK? When asked to name the most important current threat, risk managers for around 70 UK financial institutions now put debt at the top of their list.

I think they’re right to be worried. Even after this week’s downward revisions, the Office of Budget Responsibility expects tax revenues to grow rapidly over the next two financial years – but there’s little prospect of that happening if there’s a sharp downturn.

Imagine, instead, if the government’s income declined in the same way it did after 2008 – that would mean more than £150bn less revenue than expected over two years (a ‘taxation double dip’). Following the Chancellor’s logic, that would be enough to steer the UK straight into a debt storm.

Now you could argue that revenue will prove more robust than it did after 2008 and that’s probably true if the UK sees ‘normal’ economic underperformance. But euro breakup – accompanied by an inevitable banking crisis, massive disruption of exports, lower oil revenues etc. – would take us far beyond normal.

Bottom line: if the euro goes, it probably takes the British government with it. Happy days. Continue reading

Greece screwed – Euro next?

On Greece, Martin Wolf is bleak

Yet [despite the bailout] it is hard to believe that Greece can avoid debt restructuring. First, assume, for the moment, that all goes to plan. Assume, too, that Greece’s average interest on long-term debt turns out to be as low as 5 per cent. The country must then run a primary surplus of 4.5 per cent of GDP, with revenue equal to 7.5 per cent of GDP devoted to interest payments. Will the Greek public bear that burden year after weary year? Second, even the IMF’s new forecasts look optimistic to me. Given the huge fiscal retrenchment now planned and the absence of exchange rate or monetary policy offsets, Greece is likely to find itself in a prolonged slump.

Would structural reform do the trick? Not unless it delivers a huge fall in nominal unit labour costs, since Greece will need a prolonged surge in net exports to offset the fiscal tightening. The alternative would be a huge expansion in the financial deficit of the Greek private sector. That seems inconceivable. Moreover, if nominal wages did fall, the debt burden would become worse than forecast.

…Felix Salmon depressing

Even if Greece were running a zero primary deficit (and I’d love to know if it’s ever managed that particular feat), a default without devaluation would still keep the country mired in its current uncompetitive state. If you’re going to go through the massive pain of a default, you might as well get the upside of devaluation at the same time, and exit the euro.

At that point, the only question is: do you default and devalue now, or do you wait a couple of years? Germany and France might well want to wait, in the hope that their banks will be better able to cope with such a thing in a couple of years’ time. But from a Greek perspective, if the pain is coming, best to go through it now and bring forward the growth rebound, rather than push off the devaluation stimulus to an indefinite point in the future.

…while most of Simon Johnson’s readers have now slit their wrists:

The Europeans will do nothing this week or for the foreseeable future.  They have not planned for these events, they never gamed this scenario, and their decision-making structures are incapable of updating quickly enough.  The incompetence at the level of top European institutions is profound and complete; do not let anyone fool you otherwise.

What we need is a new approach, at the G20 level; this can definitely include debt restructuring, but it has to be done in a systematic fashion (and even then there will be a considerable degree of total mess).  Such a change in framework for dealing with these issues will not get broad support until after further chaos in Europe, but it now needs to be put into place.

The Europeans will not lift a constructive finger.  The leading emerging markets are too busy battening down the hatches (and accumulating ever more massive chests of reserves).  And the White House still seems determined to sleep through this crisis.  Expect nothing.

What are the chances of the Euro emerging from this unscathed? Increasingly slim, it seems – surely one or more countries are going to find it almost impossible to stay inside the currency union. While the UK gazes at its navel, phase 2 of the global financial crisis has firmly taken hold.

We now have an inter-related banking and sovereign debt crisis; no procedures for an orderly bankruptcy of countries (having ignored the lessons of the East Asian financial crisis); and no legal way to allow the destitute to exit the Euro.

What a mess.