Management discussion and analysis

From BMI Research - The outlook for the global economy has deteriorated since mid-May, when trade tensions between the US and China re-escalated following the collapse in trade talks. These tensions are running centre-stage at a time when global growth momentum has been weakening and financial conditions tightening as measured by several indices. These dynamics point to continue downside risks to our global forecast of 2.9% growth for 2019, which already marks a downward revision from 3.0% last month, and we see the potential for even slower growth in the event that trade tensions escalate further. Over the past month, we have revised our forecast for several countries including the Australia, Brazil, Canada, Egypt, Mexico, Thailand and US, and we have also revised our outlook for oil prices slightly lower. Data coming out of the US have weakened slightly in recent months across several sectors of the economy, ranging from the labour market, trade, production and inventories, to business conditions, profit margins as well as financial conditions.

The slowdown in high frequency indicators combined with rising trade risks has resulted in a sharp re-pricing of market expectations for the US Federal Reserve (Fed), indicating expectations for around 75 basis points (bps) of cuts in 2019 and another 25bps in 2020, BMI Research June 2019.

A sharp rise in expectations of interest rate cuts by the Fed in 2019 following the collapse in US-China trade talks in May has provided some respite to Emerging Markets (EMs) since the start of June as capital outflows have partially reversed. This has also allowed a number of central banks to adopt a more dovish policy stance in a bid to offset slowing growth.

For example, in contrast to substantial tightening through much of 2018, central banks in Turkey, South Africa and Indonesia (to list a few) have kept their benchmark rates on hold through this year (although the latter two have recently hinted at looser policy in the coming months), while central bank policymakers in Egypt, India, Malaysia and the Philippines have cut their respective benchmark policy rates in the year to date. Although Turkey has held its policy rate, it is using less overt and more unorthodox measures to tighten while waiting for a window of opportunity to cut should inflationary pressures subside. Given ongoing trade risks and the potential for risk appetite to shift, aggressive monetary loosening could leave some EMs exposed to a sudden return of capital flight, similar to what was seen in 2018. Significant uncertainty remains as to whether the China and US will strike a deal to alleviate trade tensions, or whether Trump will follow through on his pledge to raise tariffs on the remaining USD 300bn worth of imports from China. Even if the two sides do strike a deal, it will likely be a superficial agreement, in our view, with prolonged uncertainty continuing to weigh on investor sentiment in the coming months, BMI Research June 2019.

Risk sentiment has deteriorated substantially in recent weeks, posing downside risks to our forecast for the global economy to grow by 3.0% in 2019, which is unchanged from last month’s forecast. While strong services sector growth in recent months has been offsetting some of the weakness in the manufacturing sector across many countries, momentum is now starting to slow in the services sector. Moreover, the softness in manufacturing activity and trade could be more prolonged than we originally thought given the recent rise in trade tensions between China and the US, which saw the US administration raise tariffs on USD 200bn of Chinese imports to 25.0%, from 10.0% previously, and threatened to impose tariffs on the remaining USD 300bn. China retaliated by announcing additional tariffs of between 5.0% and 25.0% on USD 60bn worth of its imports of US goods – set to take effect from 1 June.

Risk assets such as emerging market FX and equities responded negatively to the latest trade developments, while safe-haven assets such as US Treasuries were bid up. At this point, we believe that US-China trade risks are likely mostly priced in, even though it is still too early to fully estimate the medium-to-long term consequences. Moreover, despite the increase in tariffs, both sides will continue negotiating in the hope of finding some common ground. That said, the combination of rising tariffs, the potential for higher imported inflation and general risk aversion could start to feed through to investment and consumption decisions which could see growth slow over the coming quarters.

Brexit Remains a Major Downside Risk

In case of a disorderly Brexit-induced economic slowdown (not our core scenario), the Bank of England might face a dilemma (see ‘Downside Risk Scenario: The Impact of a No-Deal Brexit on the UK Economy’, February 25). It would have to choose between raising interest rates to defend the pound and stave off inflation risks on the one hand, and loosening monetary policy to support the economy on the other. Should it opt for hiking rates, the government would face rising financing costs in line with increases in bond yields. Higher debt servicing costs would reverse the hitherto downward trend of the debt-to-GDP ratio seen in recent years. That said, the debt maturity profile would remain favourable even in a disorderly Brexit scenario.

The average maturity of public debt has been consistently longer than the average across the G7 group of advanced economies, and currently stands at 15.0 years, nearly twice as much as France and Japan (approximately 7.8 years) and well above Germany, Italy and the US (6.4 years on average). This implies that the UK will face a manageable debt refinancing burden in the coming years, even if economic conditions deteriorate, BMI Research UK Country Risk Q3 2019.

The US Currency and Its Monetary Policy

Most importantly will be movements in the US dollar as well as US monetary policy. The recent sell-off in risk assets did not coincide with a substantial strengthening of the greenback as one would expect, as much of the weakness in the dollar index seems to have been driven by the euro and sterling.

While we maintain our neutral view of the US dollar, we continue to highlight upside risks, which would be negative for risk assets in general. At the same time, US interest rate futures are pricing in about 25bps worth of cuts by the US Federal Reserve (Fed) by the end of the year. If correct, this could signal a Fed that is worried about growth, which is in contrast to previous statements that described the US economy as strong, and is in distinction to our own view where we still see scope for one hike by end 2020, although risks to the view are clearly to the downside, BMI Research May 2019.

“The sugar sector – including both sugarcane growing and processing – made up 2.9% of gross value added (GVA) in 2018 and is a major export earner for Mauritius. The sector has faced major weakness in recent quarters due to the end of sugar production quotas in Europe – the largest market for Mauritian sugar – and weak global sugar prices” (FS, pg. 9). In the budget 2019-2020, the Prime Minister tried to boost the agriculture and tea sector by providing incentives to the planters, such as doubling the winter months’ allowance that tea growers receive.

The tourism industry is one of the main industries of the Mauritian economy. The total arrival of tourists increased by 4.6% between 2017 and 2018.

Tourist arrivals from main markets for year 2017 and 2018

With the big projects, such as “the construction of a light rail network, government buildings and new homes”, the construction industry was the industry that expanded the most in the last two years and is expected to continue being a key sector for economic growth in future years.

“The financial services sector's growth is being aided by Mauritius' favourable tax status, with substantial funds directed through the country before being reinvested in markets such as India and other SSA countries. Although the sector is coming under threat from negotiations over tax agreements with many of these countries – India most crucially – we expect it to continue to grow over the long term nonetheless, and to increase at around the 5.0% mark at which it has been expanding in recent years. This will be powered by both increasing domestic demand for banking services, and an increase in provision of financial services to foreign markets”.