Overview

Recent data from the Commerce Department showed that U.S. consumers continue spending at a stronger than expected pace, keeping inflationary pressures elevated. The personal-consumption expenditure price index – the Federal Reserve’s preferred measure of inflation- rose 5.4% last month over the similar period in 2022.

Spending by U.S. households rose 1.8% last month, the largest jump in almost two years. Among the places consumers appear willing to splurge include airline tickets, hotels, entertainment, auto purchases and dining out. News of still-hot inflation is a wet blanket for markets, which have been holding out for signs that might help nudge the Federal Reserve to put a brake on interest rate hikes.

Meanwhile, labor markets in most western countries remain tight. More people are retiring, companies struggle to find new staff and simultaneously are reluctant to let go of existing staff. Additionally, more workers are seeking innovative-type work and are unafraid to leave poor performing firms and join more innovative ones. Unemployment in The Organization for Economic Cooperation and Development (“OECD”) countries remains relatively low and less volatile – a trend that tends to cause milder recessions. With a steady labor market, consumers can keep spending. This allows for brisk household consumption and help to keep businesses operating – even if overall economic growth is slowing.

In addition, post-pandemic employers are more mindful of the need to keep workers on the payroll. Companies know they will have a tough time replacing positions that were considered redundant only a short time ago. And still more companies are in a stronger financial condition today. Many received help from governments during the pandemic. Many firms still sit on cash piles – about a third higher than before the pandemic.

Since the pandemic, the labor force in western countries is missing some 10 million workers, or roughly 1.5% of the total workforce. In the U.S, UK and Italy, for example, the workforce appears to have shrunk. The pandemic caused early retirements and an increasingly elderly population added to the drift. Some workers have reassessed their priorities. So called Long-Covid left some workers having to sit on the economic sidelines or drop out.

Open positions across the manufacturing, industrial, trades and service sectors remain unfilled. This decline in labor force participation has weakened productivity in the advanced economies. This trend, according to S&P Global, identifies a reluctance among companies to sanction job cuts due to the immense challenges they face in rehiring in the post-pandemic economy.

In the U.S., gross job losses have so far been unusually tame for the start of the year. According to a study conducted by JPMorgan Chase, companies are being careful not to let go of workers “given perceived difficulties in eventual rehiring.” Real time data gives little sign that unemployment is about to surge. To the contrary, the U.S. National Federation of Independent Businesses finds a large share of small firms plan to create new jobs over the next quarter. With labor markets tightening, employers in most countries reportedly still have ambitious hiring plans.

Since 2021, GDP growth in 38 countries of the OECD has slowed almost to a standstill. Business confidence is below long-run average. Yet there is not much sign of weakness in the labor market. Across OECD economies unemployment is at 4.9%, the lowest in many decades. In the fourth quarter of 2022 – the developed world added one million jobs, in line with the long-run average. In half of the developed countries, including Canada, France and Germany, there has never been a higher share of working age folk in a job, according to EIU statistics.

Unemployment is rising in a few countries, including Austria and Israel. One of the worst performers is Finland, where unemployment rose by more than a percentage point since its post-lockdown low. In the face of soaring energy prices and reduced trade with Russia, Finland’s GDP fell by 0.6% in the fourth quarter. However, at 7.2%, Finland’s jobless rate is still well below its long-run average. Meanwhile countries like Greece, Italy, and Spain, which were synonymous with sky-high unemployment in the 2010’s, are doing much better today.

Confronted with labor markets that are resilient even in the face of rising interest rates, central banks could be tempted to tighten monetary policy further. More interest rate increases, or another energy shock, would likely push employers to begin reducing headcount. Such a move would be risky as it would stifle a recovery prospects.

Meanwhile, it is projected that over the next decade, rich-world populations will age rapidly causing further drag on labor supply. Good workers are likely to become harder to find. The need to train the western workforce to take on new jobs in the tech sector and next generation technologies is a critical challenge for western economies in competition with China. Being ready to control and adapt artificial intelligence (AI), robotics, EV’s, drones, et. al. and their applications at the workplace – will determine who dominates economic production in the next decade. AI, semiconductors, chips, and robotics will likely become our close work partners, much faster and sooner than what was thought possible a short while ago. Some argue that AI-related investments in intangible capital may already be depressing productivity growth.

Concern about China’s aggression towards Taiwan, home of most of the world’s advanced chip production, is reshaping supply chains. The U.S. is reinforcing this by limiting China’s access to advanced chips and enticing chip firms to set up shop in the U.S. Japan is doing the same. The U.S. has floated the idea of a Chip 4 Alliance – including the U.S., Japan, Taiwan and South Korea – to coordinate chip policy. Although it appears U.S. allies in Asia are pursuing their own self-interested chip strategies, which can often be at odds with each other. Japan and Taiwan worry about China getting technology that could give it a military edge. Asian chipmakers also worry about losing market share in China. Japanese semiconductor firms generate 20-30% of their business with Chinese customers, and stand to lose around 70% of it because of unilateral U.S. curbs on doing business with China.

There are other risks abound. Parallel industrial policies could produce a supply glut. Some 65% of business executives recently surveyed believe the supply shortage that hit some chips last year will likely ease in 2023. A recent profit warning from Intel, which once led the industry, has intensified concerns about excess production.

Meanwhile, the focus on fabrication ignores the tail ends of the supply chain, such as raw materials, packaging and testing, where South-East Asia and China play key roles. Others fret that the U.S. curbs on China’s ambitions for high-end chips will only mean China focusing its resources on legacy chips. China’s successes in flooding the market to corner the production of solar panels and rare earths are troubling precedents

Even if governments prove willing to subsidize the inefficient construction of duplicate supply chains, they may not find enough engineers to work them, especially in demographically challenged East Asia. South Korea’s semiconductor industry is predicted to be short of at least 30,000 workers in the next decade. The shortage of capable engineers is the industry’s main bottleneck. Engineers with basic capability need eight years training to work in one of Taiwan Semiconductor (“TSMC”) fabrication plants. Some 300 Taiwanese engineers will move to the company’s new plant in Japan to run that facility. Meanwhile, Japan is scrambling to train talent of its own. Building the next phase of the industry globally will require more than just money. It will require more highly skilled labor. The U.S. and other western countries better beware.

Ukraine-Russia

Russia’s decision last month to suspend participation in the last remaining arms control agreement with the U.S. has increased fears over uncontrolled nuclear proliferation and a potential new arms race. The move would leave a number of deployed U.S. and Russian nuclear warheads unchecked for the first time in more than 50 years, raising concerns about other emerging nuclear powers such as China having few incentives to adhere to a global arms control regime.

Western military and financial support keep Ukraine’s war effort going, although only 31 billion of the 64 billion euros promised by western countries since Russia’s invasion, has so far been received. The U.S. provides the lion’s share of that assistance, but there is no guarantee how long this can be maintained. Support for spending to help Ukraine, that was once rock solid in the U.S., is softening and will likely come under more pressure as the 2024 presidential election approaches.

The year since the war began in Ukraine has been a roller coaster for energy markets. Oil prices have been volatile, with the global Brent benchmark peaking at $133 per barrel last March before falling back to around $84 today, below where they were traded at the beginning of the war. In the case of natural gas, the story is different. After Russia cut pipeline supplies to Europe, the region’s benchmark gas price hit a level equivalent to almost $580 per barrel last August.

Other problems compounded the fallout from the war. A fire in a large U.S. gas export facility tightened global energy supplies further, while drought caused a sharp drop in European hydropower generation. Big energy companies raked in record profits as a result. Independent U.S. producers of liquified natural gas that helped Europe to fill the hole left by Russian pipeline gas- also benefited.

Some in the U.S. administration appear to believe that China will stop short of sending weapons to Russia to help its military campaign in Ukraine. Others strongly believe the Chinese are getting ready to provide such help. Intelligence reports show that China has already provided non-lethal support to Russia for use in Ukraine and is now considering the provision of lethal support.

The U.S. placed five Chinese groups on the ‘entity list’ blacklist- which effectively bars companies from providing the groups with U.S. technology- for their alleged role in aiding the Russian military. The newest action is part of a big package that targeted almost 300 individuals and Chinese groups suspected of being conduits facilitating Russia’s ever-evolving sanctions avoidance regime.

Meanwhile, China floated its own outline for peace talks between Ukraine and Russia while continuing its support of Russia. The move is seen as an attempt by China to cast itself as a as peace mediator in the eyes of the wider world.

In a coordinated move with the Group of 7 advanced countries [G7], the U.S. warned that there would be severe costs for any country that helped Russia evade sanctions. That could include many countries such as China, Turkey, Georgia, Azerbaijan, Armenia, Kazakhstan, Romania, or India.

Meanwhile, Europe’s defense contractors are boosting orders and enjoying surging stock market valuations, lifted by higher government spending and the expectation of more sales to come as the Ukraine war grinds on. Companies like BAE Systems PLC, Sweden’s Saab AB (which designed the NLAW antitank weapon a symbol of Ukraine’s early resistance), and Norway’s Kongsberg Gruppen ASA (which makes missiles, as well as surveillance and other equipment) are all benefiting from generally higher military spending around the world and particularly among European countries – amid the Ukraine war.

According to reliable estimates, European military spending, which has already ticked higher in recent years, will increase by 53% from 2021 to 2026 to $481 billion, and potentially as high as 65% to $519 billion. In Europe where the perception of threat level is acute, the need for new combat and field equipment is considered urgent. The order books for most companies in the sector used to be related to longer-term projects, such as submarines and naval ships. Now,, with the amount of equipment going into Ukraine, there are customers around the world who are looking to replenish those stocks. Some existing orders for combat vehicles are being accelerated by a number of countries including Slovakia, Czech Republic, Poland, and others. U.S. arms makers have also posted strong order books as they benefit from a slice of the $27 billion in military equipment committed by the U.S. to Ukraine.

Meanwhile, NATO’s biggest European members (Germany, France, and Britain) are using the stronger ties between NATO and Ukraine – as a way to encourage Ukraine to begin peace talks with Russia. They argue that talks should proceed even if Moscow continues to occupy Ukrainian territory

While outlining a blueprint for an agreement to give Ukraine much broader access to advanced military equipment, weapons, and ammunition to defend itself once the war ends, the UK has pushed for peace talks to begin. The German and French governments support this initiative. Officials of all three countries have been careful to stress that any decision on when and under what conditions any peace talks start is entirely up to Ukraine. However, public declarations masks deepening private doubts among western politicians that Ukraine will be able to expel the Russians from eastern Ukraine and Crimea, which Russia has controlled since 2014. There is the concern that the West can only help sustain the war effort for so long, especially if the conflict settles in a stalemate.

On the other hand, most Central and Eastern European governments fear that encouraging Ukraine to negotiate before either Ukraine or Russia is ready – would likely embolden Russia by suggesting dwindling Western support. The world view peddled by the Russian leadership reflects a fundamental anti-American, anti-western, and anti-European grievance-filled contention that the west betrayed Russia after the cold war by accepting newly free, former communist countries of central and eastern Europe into NATO. Russia’s thirst for conquest, revenge, and a revered place in the annals of history remains unquenched. Given this mindset, there should be no doubt that Russia will remain a source of war, aggression, and destabilization against Western interests. At this juncture, there appears to be little likelihood that Russia will soon back down; or that Ukrainians will cease from defending their country.

Low-income countries

With the pandemic causing more low-income countries to fall into debt distress beginning in 2020, China initially appeared to be part of the solution. It delivered more debt relief than any other lender to Covid-19 hit countries.

Now, rather than joining collective efforts to rescue distressed borrowers, critics say China is putting its own interests first. This not only challenges the traditional approach to sovereign defaults, but the very foundations of the IMF, World Bank and other multilateral lenders. China is using its status as the largest creditor nation to secure rights to valuable raw materials in several indebted countries and to play a central role in how these distressed economies obtain debt relief. This will happen based mostly on China’s terms which are in China’s interests not the debtor country.

Among examples of China’s approach are Zambia and Sri Lanka. Zambia, after defaulting on its debt in 2020, has fallen victim to a sluggish restructuring process, largely blamed on China’s demands.

Sri Lanka, which defaulted in 2022, has also not received the financing assurances it needs from China to finalize an IMF assistance program.

Other countries that have borrowed heavily from Beijing and western creditors, such as Pakistan and Egypt, are at risk of following these two into default this year. As the list of countries in distress grows, the full implications of China’s position is beginning to sink in and there is an overriding concern for other creditor countries: that China will insist that global lenders such as the IMF and the World Bank join bilateral and commercial creditors in reworking, or forgiving part of their loans.

Critics claim that removing “preferred creditor” status would prove disastrous, raising lenders’ cost of funds – and their capacity to provide finance at much lower interest rates than borrowers could get elsewhere.

Borrowers in the developing world are also alarmed by any threat to the creditor that underpins the triple A credit rating of the IMF, the World Bank and other development banks.

One explanation of the apparent contradiction in Beijing’s position is that there is not just one Chinese creditor. The Chinese finance, trade, and foreign ministries, the central bank, and the national development agency each have different, and at times, conflicting mandates, and priorities.

This explanation has been offered to justify the slow pace of Chinese cooperation with debt workouts in Zambia and elsewhere. Its multiple lenders, in the form of commercial and development banks, operate under different and competing imperatives – which, it is argued, makes it difficult or impossible to get them to act as one. Nonetheless, few doubt that when the strategic or economic imperative is strong, Beijing can act decisively.

This time the global infrastructure for dealing with unlucky or irresponsible economies is in crisis. China’s lending, after growing for two decades, has reached a critical mass. Western financiers are in a stand-off with a lender too big to ignore but too irascible to involve in debt restructuring. Countries that have borrowed from China and have been battered by the pandemic and rising interest rates are in turmoil. At least 38 countries which the World Bank considers in or near default have China as their biggest state creditor. But China is refusing to play by the old rules.

Restructuring has all but disappeared since the pandemic. Four countries-Chad, Ethiopia, Ghana, and Zambia-have asked for help under the Common Framework agreed to in 2020. Only Chad has secured a deal and it will reschedule, not cancel, any debt payments. China’s refusal to accept write-downs is the main issue.

Pakistan

The economy is on the brink. Pakistan is the poster child for a country being overly indebted to China and having to face harsh debt negotiating conditions. In January, the Pakistani government burnt through 25% of its foreign exchange reserves, leaving $3.5 billion to cover loan repayments and imports that will probably be equivalent to twice that in the first quarter. Shortly after the government turned off the electricity grid to save fuel. The central bank then abandoned a currency peg causing the rupee to plunge 13.7% against the U.S. dollar. The government also increased retail fuel prices 15%, reversing an earlier decision to retain/introduce subsidies that ran counter to the terms of an existing IMF package.

The IMF has provided 21 bailouts to Pakistan since 1960. Western governments have also followed suit. The resumption of IMF disbursements of an ongoing $6.5 billion loan, would allow Pakistan to access bilateral lending, including from the UAE, Said Arabia, and China. However, the policy reforms required by the IMF will result in further dampening of investment inflows.

The lifting of the informal exchange rate cap by banks and foreign exchange companies narrowed the gap between the official and curb-market exchange rates. The government is expected to implement additional fiscal measures such as the imposition of new taxes to the tune of $800 million and a further increase in the price of electricity and gas.

The EIU expects Pakistan to default on external debt obligations by early 2024, as the country struggles to generate enough domestic revenue and the replenishment of foreign-exchange reserves remains stifled. Such a default would likely happen after the ongoing IMF package ends in June 2023. With a parliamentary election scheduled to be held in late 2023, the ruling coalition will continue to suffer a serious lack of popularity as a result of the ongoing austerity measures.

Meanwhile, the state of democracy in Pakistan has deteriorated to a level where it sits just above countries described as authoritarian. According to the EIU Democracy Index recently updated Pakistan has a cumulative score of 4.13 causing the country to fall three places in the 167 country-ranking to occupy 107th place. This compares with the Ivory Coast (106th place), and Mauritania (108th place). What makes these countries similar are the perception of heavy government pressure on opposition parties and candidates.

A high degree of political instability makes reforms such as privatization of state assets and deregulation difficult to implement. Over the medium-term (2025-27), private companies are projected to increase their share of the economy. However, major cartels continue to operate, deterring competition within the economy. The government promotes foreign investment in certain sectors, especially infrastructure and energy. However, security and political risks and the fragility of the economy is a deterrent to a wider scope of inward investment.

Some special economic zones are to be set up under the China-Pakistan Economic Corridor. However, the poor business environment hinders efforts to attract non-Chinese investment in these zones.

Import bans have been periodically introduced to preserve foreign exchange reserves. We believe the central bank will increase regulatory requirements for importers and exporters given the current state of inadequate FX availability. Eventually constrained FX reserves will likely lead the government to limit foreign exchange conversion for individuals.

The cost of credit will increase over the year as monetary policy tightens further. Bank lending will likely be constrained as more banks feel compelled to pursue more risk averse strategies. The unemployment rate remains high and will only gradually decline over the coming year, which should help to keep a lid on wage inflation.

A major highway project, the Chaman-Quetta motorway and other road projects will be completed over the coming year. The Main Line 1 railway project, which aims to upgrade Pakistan’s rail infrastructure, will be delayed.

Nigeria

Elections were held on February 25, 2023. The president elect received 37% of the votes in a rear three-man contest. Charges of election fraud abound. The country will now be led by a wealthy 78-year-old former governor of Lagos, Bola Tinubu of the All-Progressives Congress. The president-elect has a checkered past and is the subject of long-held rumors of corruption. He will be the first presidential candidate to win with less than 50% of the total votes.

Almost 25 million voters cast ballots in a vote that was largely peaceful but marred by long delays and technical glitches, angering voters and opposition parties who have claimed massive vote rigging. In a bid to improve transparency the voting regulator, Independent National Electoral Commission (“INEC”), this year introduced biometric voter identification for the first time at the national level, as well as a central online database for uploading results. But some voters and opposition parties said failures in the system when uploading tallies allowed for ballot manipulation and disparities between the manual and online results.

With registered voters numbering 93.4 million, turnout was just over 27% – even less than in the 2019 election. INEC is set to address some of the concerns raised by parties and voters in a few days. The voting agency is hoping to be allowed to prove that the allegations of voter fraud is without merit

The country’s history of financial mismanagement, nepotism and mistrust of public officials is only made worse by record high inflation, a battered currency and interest rates of 18%. The president-elect, who ruled the influential southern state of Lagos from 1999 to 2007, inherits a nation plagued by growing insecurity in some parts of the country, with constant attacks by criminal gangs that kidnap civilians for lucrative ransoms, jihadist groups and pro-independence rebels.

He will have to tackle the devaluation of the currency, the naira, rampant inflation, and high unemployment, despite the fact that Nigeria stands out as Africa’s leading oil producer and the continent’s largest economy.

Thousands of opposition supporters protested the presidential election results, as calls for a new election intensified. At least five political parties are challenging last month’s vote, alleging that delays in uploading results from the country’s 177,000 polling stations to the electoral body’s portal could have allowed vote tampering. Protesters also allege that there was voter intimidation and cases where people were barred from voting.

In Nigeria, an election can only be invalidated if it is proven that the national electoral body largely did not follow the law and acted in ways that could have changed the results. None of the country’s presidential election results have ever been overturned by the country’s supreme court. A local court has granted the third-place finisher, Peter Obi, permission to inspect the election materials used in the vote as part of his court challenge. The two opposition parties will, over the coming weeks, gather evidence to build their cases in separate applications disputing the election results, a process that took seven months in 2019 when the courts rejected a similar challenge to the results.

Some independent observers have also criticized the conduct of the election. The U.S. ambassador to Nigeria said the election process failed to meet Nigerians’ expectations after years of improvement in the quality of the elections.

The terms under the new Petroleum Industry Act are aimed at making Nigeria a more competitive destination for oil investment, although there will be lingering doubts about the transparency on how the sector is governed. The overarching policy objective is to promote self-sufficiency and local industrialization through protectionism.

International energy groups can be expected to remain involved in Nigeria, although if oil prices decline there will be this will raise the risk of capital controls and other likely convertibility restrictions. Over the coming year a large private refinery is on schedule to start up its operations. This should help reduce Nigeria’s near-total dependency on imported refined gasoline.

Public investment in infrastructure continues to lag behind budgeted levels and the rate needed to plug the infrastructure gap, for at least the next few years. The country retains a vibrant technology sector for an economy at its stage of development, but infrastructure is weak outside of urban hubs. Some home-grown technology firms looking to adapt global technology trends to the Nigerian market will continue to do well.

Restrictions on foreign exchange access will remain in place for certain imports, but the foreign exchange market could become more liquid, and the Central Bank of Nigeria will work to clear a backlog of orders. The government is not expected to return to the sovereign debt market before 2024, with financing conditions remaining tight and high borrowing costs domestically heaping more frustration on businesses and households alike.

Bangladesh

What was once a land of poverty, famine and natural disasters is today a population of 170 million with a potential turnaround story. Over the past three decades, employment has soared largely because of the country’s thriving garment industry. The share of women in paid work has climbed from 4% in 1971 to 35% today.

In the decade before the pandemic, GDP growth in Bangladesh averaged 7%, only slightly slower than China. Today, the country’s GDP per person stands at $2,500, higher than India’s. The country is projected to graduate from the UN’s ranks of least developed countries (LDC’s) in 2026. Bangladesh ambitiously aims to be a middle-income country by 2031.

However, the country’s long-term goals are currently being tested by the aftershocks of the pandemic and the war in Ukraine which is causing serious economic shock to the country. A cost-of living crisis is playing out in the streets of the capital, Dhaka, where homelessness has grown and at the central bank, where foreign-exchange reserves shrunk to the equivalent of one month’s worth of imports.

An election is due in 2024 but the outcome appears already assured: the sitting prime minister, Sheik Hasina, who has grown increasingly autocratic, has silenced the opposition. Her main political opponent has been jailed. With rising tensions between supporters of both sides, it seems likely to spark violence as the elections get closer. The remaining leaders of the opposition, the Bangladesh Nationalist Party, are out on the streets, raising consciousness amidst widespread intimidation and official corruption.

The prime minister, who has been in office since 2009, is now on track to begin a new phase of growth by splurging on infrastructure, including improving badly needed power supply generation facilities. Road building by the World Bank and others has connected villages to towns, boosting local farm markets.

The garment industry which sprung up around the capital is world-class. The government helped by scrapping duties and outdated labor laws.

Crossing the country with its numerous rivers has long been a big challenge. Last year a road and bridge opened across the Padma River, the main channel in Bangladesh of the mighty Ganges is transforming the country’s economic geography. Meanwhile, Japan backed an elevated metro which is now being built along with a new airport. Across the country power plants are being built. The activity has worsened congestion for the short term but over time the bottle necks should ease.

Despite these visible signs of progress, there are ongoing concerns. Among them are growing web of state capture and decay spreading through institutions – which is causing surging fuel and food price inflation and massive capital flight. Foreign exchange reserves were under $30 billion in January. The IMF last year agreed to consider a support program and in January approved a $4.7 billion loan. Still, the local currency remains shaky, forcing the government to put the brakes on imports by imposing more inspections and permits. Bangladeshi exporters are having a tough time importing necessary foreign inputs to do their work. In addition, they are finding it increasingly difficult to access foreign currency to support letters of credit, without which they cannot conduct trade.

The garment industry poses longer-term concern. Overreliance on this sector is a serious weakness, and according to local economic experts, its long-run future is uncertain. If Bangladesh graduates from LDC status, the country will lose some tariffs exemptions in western markets. Lower-cost producers such as Cambodia and Ethiopia, threaten to take the same bite out of Bangladesh’s market share that it took from China’s.

Other export industries struggle to grow. Bangladesh is not a member of any major regional trade pact. It has attached little of the other sorts of production being moved out of China. Though some domestic sectors such as pharmaceuticals and electronics have potential, an appalling bureaucracy and uneven customs duties hold them back. The EIU ranks Bangladesh’s business environment 15th out of 17 Asian countries. Poor governance and corrupt practices have overshadowed the country’s potential. The elites are suspected of engaging in billions of dollars’ worth of money laundering activity each year, siphoning money to private bank accounts in foreign capitals. Some of those are funds that normally would be held at Bangladesh’s central bank to bolster its foreign-exchange reserves.

According to news reports, it is the resilience and loyalty of some 10 million Bangladeshi workers living overseas who remit billions home to relatives -why conditions are not worse. Remittances allow millions of households to buy food, fuel and pay rent, energy and transportation bills each month. Without such inflows millions would go hungry.

Non-performing loans have risen in the banking sector, thanks to banks favoring the well connected with loans they don’t repay. Politicians, bureaucrats, and those in the security services are accused of extorting fees as the downpayment to get anything done in the country. The government claims it is cracking down on corruption. However, almost no one believes or has seen evidence to support that claim. The prime minister is accused of building a personality cult around her family. A patronage system that demands loyalty to the leader underpins her control on power and the loss of independence in most state institutions. This reportedly includes the police, the courts, and the press. An increasing number of young people graduating school, yearn to leave the country for opportunities abroad. That trend is likely to persist for some time, especially if the sitting government remains in power and if deep reforms are not implemented that attracts investment and create jobs.

By Byron Shoulton, FCIA’s International Economist For questions / comments please contact Byron at bshoulton@fcia.com

Since 2004, Securitas Global Risk Solutions, LLC (“Securitas”) has helped clients develop credit and political risk transfer solutions that provides value on numerous levels. As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service.

Overview

Federal Reserve has dialed back on the pace of interest rate increases in its ongoing fight to tame inflation. The move comes amidst evidence that inflation has slowed in the U.S. and Europe from peaks reached last year. Economic activity has slowed as consumers pull back on spending [or become more selective in shopping decisions]. Of significance, is that while inflation may have peaked, raw material and input prices remain generally elevated – with no indication of an early reversal.

The U.S. posted its largest trade deficit on record in 2022. U.S. imports exceeded exports by $948.1 billion, an increase of 12.2% over 2021. During the final two quarters as global trade slowed, U.S. imports of goods and services fell. Weaker demand for U.S. goods such as industrial supplies and consumer products contributed to a 0.9% decline in exports. The lower U.S. imports late in the year reflected slowing consumer spending. Recent reports have painted a mixed picture. U.S. manufacturing output and home sales fell in December but hiring surged in January and GDP grew a surprising 2.9% in the fourth quarter.

U.S. import growth slowed last year compared to 2021 as consumers spent less overall on goods such as home fitness equipment and furniture which boosted spending on services such as travel and restaurant meals.

U.S. exports of petroleum products and liquefied natural gas boomed after Russia’s invasion of Ukraine led to sanctions on its energy products. Also, Americans flocked to Europe [and elsewhere] as international travel reopened, taking advantage of the strong dollar. The sharp slowdown in the U.S. housing market has reduced demand for shipments of furniture, kitchenware, and lighting.

Global shipping demand has slowed since November after retailers amassed excess inventory. Globally, many are reporting excess supplies on hand.

Sentiments in Europe have adjusted since December, with a consensus expecting the region to escape a recession this year. That is because energy prices have dipped from recent peaks due to adequate reserves and a much milder winter than anticipated.

Furthermore, generous government support provided to households and companies to cushion an expected price spike kept confidence afloat.

Both the Federal Reserve and the European Central Bank (ECB) have continued raising interest rates, but at smaller increments. The consensus is that the tightening cycle that begun in 2022 will likely be concluded by year-end 2023. We doubt that central banks will begin cutting interest before early 2024.

Eurozone consumer prices rose at an annual rate of 8.5% in January, down from 9.6% in December and well below the record high of 10.6%, hit in the year to October. However, core inflation, which excludes changes in food and energy -and is considered a better measure of underlying inflation- remains unchanged at an all-time high of 5.2%. Headline inflation is slowing in most advanced countries, reflecting the easing of global energy costs. Meanwhile, price pressures in the services sector are expected to remain elevated for months to come.

Trade also fell in Europe at the end of 2022, reflecting weakening domestic and overseas demand. German imports of goods fell by 6.1% in December while exports fell by 6.3%. In France, imports were 1.9% lower in the fourth quarter, while exports were down 0.3%

While the fall in headline inflation is welcome, the Federal Reserve, the ECB, the Bank of England, and Bank of Canada officials remain vigilant about bringing down elevated core inflation. The central banks will need to see solid evidence of consistent cooling of price pressures before ending the cycle of rate hikes. We project that such evidence may be unlikely before the end of 2023.

Separate data on labor markets show that Eurozone and U.S. employment levels remain resilient. Even with a number of recent layoff announcements in the technology sector, U.S. unemployment fell to 3.4% (a level not seen since 1969).

Eurozone unemployment remained unchanged at 6.6% across the bloc, (the lowest level since records began in 1995). German manufacturing held up much better than expected in the final quarter of 2022. Output at factories rose in November and December, boosting hopes of a milder economic slowdown in the eurozone. Unemployment also fell in Italy, France, and Spain.

The new data helped the euro gain almost 1% against the dollar, its strongest level in six months. Estimates for eurozone growth have been upgraded on the back of better than expected weather conditions which eased demand for gas causing declines in wholesale gas prices. More investors and businesses are increasingly expecting a mild recession, or the possibility that Europe could avoid a recession this year.

Meanwhile, fertilizer and crop prices have fallen sharply since their peaks after last year’s Russian invasion of Ukraine. Yet, agricultural specialists warn that the world’s food supplies are still under threat. Food prices were already elevated before Russia’s full-scale invasion a year ago, due to droughts and pandemic-related hoarding by governments and businesses.

Last year prices for crop nutrients soared as a result of Russia’s position as the world’s largest fertilizer exporter, while the jump in natural gas prices, a critical ingredient for nitrogen fertilizers, also piled pressure onto agricultural markets.

The Black Sea grain deal between Russia and Ukraine brokered by Turkey, played a crucial role in subduing prices, along with plentiful supplies from Russia; and lower natural gas prices have calmed fertilizer prices. However, it is important to note that this Black Sea grain deal could unravel, and volatile energy prices and climate change also could undermine crop production. The most immediate danger is the UN-backed grain deal, which is due to be renewed in March. Any failure to extend it would block exports of Ukrainian grain, sending prices through the roof again.

While many crops, along with fertilizers, are exempt from sanctions imposed on Russia by Ukraine’s allies, many banks, insurers, and logistics groups have been reluctant to handle Russian farm produce. Relatively low grain inventory levels have added to concerns about global food supplies. For wheat, the stock-to-use ratio shows projected stocks for the end of the crop year in June at 58 days, the lowest level since 2008, when international food prices soared after droughts and an increase in global energy prices. Because of the low global stock situation, prices will remain volatile and could even head higher if a drought or significant weather event emerges in the spring.

Currency movements are also important for food supplies in many developing countries. Despite recent declines in food prices on international markets, the strength of the dollar is likely to keep costs in local currencies high. That means food inflation for consumers will likely persist in 2023, due to the lag for internationally traded prices to work their way through to retail supply chains. A record wheat crop in Russia and bumper corn, and soybean harvests in Brazil have relieved tightness in international grain and vegetable oil markets, while recent fall in the price of natural gas, a feedstock, has increased production of nitrogen crop nutrients. Cheaper international prices, including for fertilizer, will likely remove some of the pressure on growers.

The shocks of the past three years have hit lower-middle income developing countries hard. The world’s poorest countries are threatened. According to the IMF, about 15% of low income countries are already in debt distress and an additional 45% are at high risk of debt distress. Sri Lanka, Ghana, and Zambia are already in default. Many more are expected to follow. The terms of borrowing (low interest rates) were attractive but risky. Then came Covid-19, with soaring energy and food prices, higher interest rates, a strong dollar and a global slowdown which have now rendered the costs prohibitive. That is where several of these vulnerable countries now find themselves.

When debt becomes unaffordable, it needs to be restructured. But restructuring has become even more difficult than it was in the 1980’s, following the Latin American debt crisis in 1982. Back then, the main creditors were a few western banks, western governments and western-dominated institutional financial institutions. It was then relatively easy to coordinate between these entities.

Between 2000 and 2021, the share of public and publicly guaranteed external debt of low and lower-middle income countries owed bondholders jumped to 50%, while the share owed to China rose from1% to 15%. Meanwhile, the share held by 22 predominantly western members of the Paris Club of official lenders fell from 55% to 18%. Therefore, coordinating creditors in a comprehensive debt restructuring operation has become much harder, because of their greater number and their diversity. No one wants to restructure debt owed to themselves if that would merely benefit other creditors, not the country itself.

China

China’s export boom that propelled the world’s second-largest economy through much of the pandemic has sputtered. China’s exports to the rest of the world fell 9.9% in December compared to a year earlier. This was a steeper decline than the 8.7% drop recorded in November and reverses a long spell of surging exports earlier in the pandemic as Western consumers snapped up electronics and other consumer goods while working remotely Chinese exports in 2022 were 7% higher than a year earlier, at $3.6 trillion. That marked a slowdown from double-digit percentage gain in 2021. That has reinforced concerns that China will no longer be able to count on robust trade to power growth in 2023. Chinese authorities expect to kick-start economic growth this year after lifting its stringent Covid-19 restrictions. They face a challenge: Chinese citizens borrowed less and saved more last year and it is not clear how long it will take to return to free-spending ways. Individuals in China took out the equivalent of $564 billion in new loans in 2022, down more than half from 2021, marking the lowest total since 2014 according to government data. The huge decline was largely due to fall in home sales, which translated into lower demand for new mortgages. Everyday consumer spending also took a hit during lockdowns that affected many Chinese cities, reducing the need for short-term borrowing. Consumers, instead, accumulated cash, pushing new household deposits in China to a record high of more than $2.6 trillion in 2022. With few attractive investment options – the country’s stock market had another lackluster year- some homeowners used their excess cash to repay their mortgages instead of making big purchases Any major shift in Chinese consumer behavior will have broad implications for the banking and consumer goods sectors. Although a rise in deposits means Chinese banks are getting a cheaper source of funding, the slowdown in borrowing will hurt their net interest margins, the difference between what banks charge for loans and pay for deposits. Companies, including online retailers and travel companies are expecting a pickup in consumption this year following a difficult few years. Since Chinese authorities allowed people to move around again late last year, retail spending and travel have started to rebound. During the recent Lunar New Year holiday, Chinese families spent more on travel, movies, and food from restaurants, according to private and public data. However, with economic uncertainties continuing, big ticket purchases such as real estate will take longer to recover. The higher savings and lower borrowing rates and a lack of consumer confidence could continue to hold back spending. Both consumer and business confidence fell in the past year. With uncertainty about the future the tendency is to save. When the Chinese government brought an end to its strict zero-Covid policy and unveiled a series of measures designed to help revitalize the real estate sector between November and December, stocks jumped in anticipation of a recovery. However, there is a growing consensus that it will take until the third quarter for consumption to recover to near pre-pandemic levels. Some fear that the generation of Chinese consumers who emerge from the pandemic may have similarities to Americans who experienced the Great Depression. They could develop a long-term shift in their desire to save more. If that were to occur, we could see weaker Chinese GDP growth going forward -than many anticipate. A survey from the People’s Bank of China conducted late last year, show that half of the respondents felt uncertain about their job prospects, while a quarter said their incomes had decreased. The same survey, which covered 20,000 depositors in 50 cities across China, asked whether people prefer to save, spend or invest. Around 62% of the respondents chose saving, 23% picked spending and only a sixth intended to invest more. Fading western demand and China’s zero-tolerance approach to Covid-19 outbreaks through last year took their toll on overseas sales by other leading Asian export countries last year. South Korea’s exports in December were 9.6% lower than a year earlier, while exports from Taiwan were down 3%. Meanwhile, Japan’s exports in December grew 11.5%. aided by a steep fall in the yen against the dollar and other major currencies. Still, that was slower than the near 20% annual growth recorded in November, and sharply below annual growth of close to 30% recorded in September.

Colombia

President Gustavo Petro has completed his first year in office taking a pragmatic policy approach that helped him make some progress on his campaign agenda. This included significant political reforms aimed at fighting corruption. The success in pushing forward the reforms served to consolidate the position of the ruling Pacto Historico (PH) coalition as a political force to be reckoned with going forward. Local parliamentary elections, scheduled for October 29, 2023, will likely complicate governability. The ruling PH and the centrist parties that support the president in Congress, will each put forward their own candidates, which will likely weaken President Petro’s large working coalition. However, if the government’s proposals for political reform is approved, the PH should find itself in a stronger position ahead of the polls, having attracted credible legislators from other parties who may wish to stand in municipalities with large budgets. The orientation of Colombia’s international relations is shifting under the Petro government. The president has tried to remain on good terms with the U.S. (historically Colombia’s main ally in the region). However, some aspects of his agenda–such as the restoration of diplomatic relations with Venezuela in order to re-establish bilateral trade and improve security conditions along their shared border–may raise tensions with the U.S. That is uncertain since the U.S. itself appears to be shifting its attitude toward the Venezuelan regime of Nicolás Maduro (in order to access Venezuelan oil). On the other hand, unlike many countries in Latin America, Colombia is unlikely to seek any stronger ties with China, as it will not want to put its relationship with the U.S. at risk. The sitting Petro government is focused on expanding the state’s role in the economy via a more progressive tax regime, higher social spending, greater state intervention and increased protectionism. One priority is to compensate poor families whose incomes are being squeezed by current high inflation rates, by raising the value of monthly government cash transfers. Inconsistent statements by members of Mr. Petro’s ideologically heterogeneous cabinet will cause uncertainty regarding the direction of policymaking in the near term, but the president is likely to maintain a fairly moderate stance and policy changes will be less radical than his campaign promises suggested. With regard to prospects for economic growth in 2023, it appears that a combination of domestic monetary policy tightening, and persistently high inflation will push Colombia into a technical recession (GDP expected to contract in the last quarter of 2022 and the first quarter of 2023). While the Petro’s government continuing pragmatism should bolster political stability, the policy outlook is uncertain, and when coupled with tax increases, will tend to keep gross fixed investment subdued this year. The expectation is that unfavorable international economic conditions will contribute to domestic growth slowdown, from an estimated 7.9% GDP expansion in 2022 to growth of only 1.6% in 2023. However, upward revisions to global and Chinese growth for 2023 should see stronger than expected demand for Colombian exports. Moreover, a 16% increase in the minimum wage for 2023, which is higher than was expected, will help support private consumption. The more benign global outlook and the boost to household spending from the higher minimum wage have led to a less pessimistic view of Colombia’s GDP performance in 2023. The inflation rate reached 13.1% in December (the highest level for more than 20 years), driven mainly by higher food prices – surpassed most expectations. The 16% minimum-wage increase this year, will add to the trend of increasingly entrenched price pressures which will complicate the task of achieving disinflation any time soon. Should price pressures begin to subside as the effects of monetary tightening become apparent later this year, and as private consumption decelerates more sharply, we will likely see inflation begin to retreat towards year-end. The forecast is for 2023 year-end inflation of around 12%. The best case expectation is that it will take until end-2024 for inflation to approach the central bank’s 3% target [which is unlikely to be met before 2025]. Currency volatility, high oil prices and continuing global supply-chain bottlenecks pose risks to the inflation forecast. Interest rates easing may begin in the second half of 2023. Exchange rate volatility is likely over the near-term, and markets have already priced in higher interest rate risk under the Petro government. Based on this assumption and on the expectation that Colombia’s wide fiscal and current-account deficits will narrow (albeit gradually), the peso is expected to strengthen only modestly this year, from an estimated Ps4,700:US$1 at end-2022 to Ps4,662:US$1 at end-2023. Assuming that the country’s twin deficits continue to narrow, and that other macroeconomic forecasts materialize (including a gradually weaker U.S. dollar), the peso could strengthen to around Ps4,150:US$1 by end-2027. Colombia’s large current-account deficit remain a source of vulnerability and contributes to currency depreciation pressure. Despite windfall oil income, the deficit is expected to remain sizeable in the near term at least. Although the trade deficit will narrow in 2023, the combination of profit remittances by firms (mainly in the oil sector) and weaker inflows of workers’ remittances amid a U.S. slowdown could prevent a sharper narrowing of the overall current-account deficit, which will remain large, at 4.6% of GDP in 2023 (against an estimated 5.6% of GDP in 2022). Over the medium term, inflows of workers’ remittances will recover (as U.S. economic growth picks up in 2024-27) and profit remittances should ease, helping to narrow the current-account deficit gradually, to 3% of GDP over the next 4-years. Nonetheless, a strong (albeit diminishing) cushion of foreign exchange reserves, Colombia’s flexible credit line with the IMF, continued access to international markets and reasonable foreign direct investment inflows, will limit the country’s external risks. Furthermore, a pick-up in demand for Colombia’s exports is anticipated in 2023-24, assisted by China’s anticipated recovery.

Peru

Widespread anti-government protests are disrupting copper output in Peru, the world’s second largest producer. This has triggered predictions of a possible surge in copper prices which has already rocketed in recent months as China’s resource-dependent economy reopens. Demonstrations demanding early elections and the resignation of interim President Dina Boluarte have thrown up roadblocks across the country and attacked mines, causing production slowdowns and closures in Peru’s copper operations. The country accounts for 10% of global copper supplies. Copper [which has a wide variety of applications, including electricity cables and electric car production] prices have jumped to $9,000 per ton in three months. The abrupt end to draconian Covid restrictions in China, boosted demand for the metal. The recent supply snags in Peru could provide fresh upward impetus for prices to climb further. The situation appears to be getting worse, with production losses expected to escalate rapidly. This is considered the first flare up in Peru’s longstanding issues with the mining industry, and it seems likely that volatility could take copper prices as high as $12,000 per ton, according to industry strategists. A political crisis that has long been percolating – Peru has had six presidents since 2018- is now boiling over following leftist president Padro Castillo’s removal from office on December 7th – after he attempted to close congress and rule by decree. Boluarte, who served as his vice-president, was sworn in hours later. Much of the unrest has been focused in the copper-rich south, where Castillo – viewed as a champion for the rights of indigenous and rural communities remains popular for his opposition to large-scale natural resources companies. Peru is also a large producer of gold, zin, and tin. The miner Buenaventura suspended operations at its silver mine after protesters broke in. Another mining company reports that mines, especially those located in Peru’s south, are running out of supplies such as explosives and steel. They also report being unable to refresh their workforces because of the disruptions and acknowledge that copper exports are now below where they were just two or three months ago. Key mines have had to suspend operations. Glencore’s Antapaccay mine, which produced 170,000 tons of copper concentrates in 2021, temporarily suspended operations after it was attacked by protesters in late January. Chinese-owned Las Bambas mine – responsible for 2% of global production, halted output without a restart date because of transport disruptions which hit critical supplies. Freeport-McMoRan, which operates Cerro Verde, Peru’s largest copper mine, acknowledged that it had reduced ore extraction by 10-15% per day in a bid to conserve supplies critical to keeping operations running. Global copper supply suffered a disruption rate – the amount of supply lost versus forecasts of 6.3%, compared with the usual average of 4-5%. The rate for Peru was 12%. Moody’s switched its outlook for Peru’s sovereign debt from stable to negative, though it affirmed the country’s investment grade rating. The rating agency said the sustained unrest would affect investor confidence, undermine growth, and complicate fiscal management. Expectations are that the economy could slip into recession by the final quarter of 2023. Agricultural businesses have also been hurt by the protests, with the country’s leading industry association estimating that $300 million in exports have been lost since protests began in December. Peru is a major exporter of grapes and blueberries.

Nigeria

The country’s highest court and the IMF have weighed into a botched plan to replace Nigeria’s largest currency notes. The rollout has caused chaos across the country just weeks ahead of a crucial general election. The Supreme Court slapped a temporary ban on the enforcement of the current deadline to replace the naira N200, N500 an N1,000 notes on February 10, pending the hearing of a lawsuit brought by three northern states challenging the new currency design. It adjourned that hearing until February 15. The central bank, which is overseeing the introduction of the new notes, has already had to extend the deadline to swap the old currency after shortages of the notes led to huge lines at banks across the country. The IMF is calling on Nigeria to allow more time to complete the process, noting the problems with the rollout. The three states took the federal government to court, arguing that the scarcity of new notes was causing severe hardship and stating that there had been insufficient time to complete the process. The states argued that economic activities were grinding to a halt as a result of the currency redesign. The court order is the latest twist in the chaotic rollout first announced late last year. The central bank announced at the time that the new notes would be more secure, prevent counterfeiting and allow Nigeria to move to a more card and electronic payment-based economy. The notes were unveiled in October but the central bank only started supplying them to commercial lenders in December, leading to shortages across the country where most transactions are in cash. The original January 31 deadline for old notes to cease being legal tender had already been extended by 10 days before the Supreme Court’s ruling. Long lines have formed outside cash machines and scuffles have broken out in banking halls as customers reportedly jostled to withdraw money ahead of the deadline. There have been protests in parts of the country amid frustration over the unavailability of the new notes. Bank executives report that they have not been supplied with enough naira to replace the old notes that have been collected. Nigerian anti-corruption agencies have alleged that some banks are hoarding the new currency. Meanwhile, Nigeria braces for its presidential elections to take place on February 25. A team of western educated analysts and economists based in Lagos, are now fine-tuning a data system aimed to bring evidence-based insights into the complex electoral races – where official data is deemed to be so unreliable that no one seems to know exactly the size of the population. Election polling has been done before in Nigeria, but usually in the form of surveys commissioned by political parties and other organizations for internal use. In this election cycle at least two data specialist firms are aiming to fill a gap in the market for high-quality, publicly available information. Surveys covering big issues, such as the proposed removal of fuel subsidies, would help Nigeria’s leaders in decision making. The intent is to be able to do polling on any difficult decisions the next government may have to take. There is a growing awareness that public policy and private industry need to know what the Nigerian public is thinking about national issues- before taking decisions that will affect them. By Byron Shoulton, FCIA’s International Economist For questions / comments please contact Byron at bshoulton@fcia.com

Overview

The global economy faces several uncertainties in 2023, the most prominent being: are we in a recession, and if so, how steep, or widespread will it be? According to the International Monetary Fund, one-third of all countries around the world will likely experience a recession beginning in 2023. The IMF also believes the global economy still has some ways to go before policymakers and central bankers can ease back on the current monetary tightening cycle – meaning further interest rate increases in 2023. Inflationary pressures remain elevated, however there are recent signs that some pressures have cooled – as energy and commodity prices pull back from recent highs. Many believe the current economic slowdown can remain just a slowdown. Others believe that a recession, will in all likelihood, be narrow and short-lived; while others are bracing for a steep contraction this year, given continued weak global demand, higher borrowing costs and rising debt service costs – which is contributing to the more gloomy outlook.

U.S. Federal Reserve (Fed) officials warned they will need to see substantially more evidence of inflation easing before they are convinced that price pressures are under control. Minutes of the Fed’s December 2022 meeting, when the central bank raised its benchmark rate by half a percentage point, showed that the Fed intends to continue squeezing the economy to try to tackle price pressures, which they believe could prove more persistent than anticipated. December’s half-point rise ended a months-long string of 0.75 percentage point increases and lifted the target range of the federal funds rate to between 4.25% and 4.5%. The decision in December followed fresh evidence that inflation appeared to have peaked as energy prices and those tied to the goods sector have retreated. U.S. GDP growth is set to slow as borrowing costs are kept high for an extended period, with most Fed officials projecting growth of just 0.5% this year before a 1.6% rebound in 2024.

U.S. unemployment currently at 3.6% is projected to increase by nearly a full percentage point during 2023. So far, the Fed’s tightening has been felt most in interest-sensitive sectors such as housing, where prices have declined dramatically from their pandemic peaks. However, labor demand remains high as consumers continue to spend, helping to further entrench inflationary pressures that have taken hold across the services sector.

Meanwhile, with unusually mild temperatures so far this winter in Europe and the United States, energy costs seem likely to be less of a strain on households and businesses -than previously feared.

Also, global grain prices have retreated in recent months after recording record highs in 2022 as the war in Ukraine stifled supply -as did dry weather in many crop-growing areas. Now, grain prices have fallen close to where they were at the start of 2022. The recent decline is consistent with an overall easing of commodity prices including natural gas, cotton, lumber, and crude oil. Weaker global demand, and China’s current downturn has contributed to price declines and will likely help prevent significant price spikes in the months ahead. More interest rate boosts by the Fed and other central banks aimed at cooling economy activity in the year ahead, when taken together with China’s slowdown, has the potential to birth a recession.

The outlook for global grain availability and pricing will remain uncertain, partly because so much hinges on the outcome of the war in Ukraine – which shows no sign of an early conclusion. Despite a fragile deal allowing some Ukrainian grain exports to go forward, the level of exports are far below pre-war highs. That arrangement remains shaky and will require ongoing monitoring. Future Ukraine grain planting, harvesting and access to global markets is not guaranteed. Whether western sanctions imposed on Russian exports have had a substantial impact on its foreign exchange earnings and it ability to wage the ongoing war – is unclear.

Going forward Russia believes it can survive sanctions and western economic war by using the global marketplace to its advantage. China, India, Turkey, and oil markets continue to buy and sell hugely discounted Russian crude and other exports since and during the war. Russian energy exports that previously flowed to Europe will now head to India, China, and Turkey. U.S. energy exports will flow to Europe and shipments from the Middle East may plug gaps in both directions. How this new system performs, whether the sanctions regime works and who will step in- to trade more Russian energy, will drive prices over the next twelve months and potentially for years to come. Last year’s energy crisis revived fears about energy security, presenting an opportunity for industry groups to argue in favor of continued investment in oil and gas during the period of transition from fossil fuels. The sources of energy – of all sorts- needs further diversification, new finds, and greater investment commitments for the coming decades.

On balance, it now appears that energy prices will remain volatile but mostly manageable this year, given the need for countries to refill national reserves drawn down to help combat OPEC production cut, will keep energy demand consistent this year, even without robust global economic activity. During this period of uncertainty, producers will need to keep sufficient reliable suppliers available, while consuming nations will need to ensure that sufficient reserves are kept on hand.

Western nations have placed a price cap of $60 per barrel on Russian crude exports, a move meant to crimp Russia’s ability to spend on the war. Russia has refused to sell its crude or petroleum products to countries endorsing the price cap imposed by the western alliance. The market for crude remains brisk, and during these periods of global tension, sanctions avoidance has become an art form for Russian exporters.

Movements in crude prices influence agricultural prices because demand for U.S. and Brazilian corn and soybeans stems in part from renewables fuels. Corn, for example, is the key ingredient for producing ethanol; while soybean oil is a vegetable used for the production of biofuels. Higher crude oil prices make producing such fuels more attractive, thus stimulating demand for the underlying grain. Many analysts are betting that prices for grain and other commodities could likely slip in 2023, at the height of a possible recession, with continued monetary tightening in major economies.

However, farmers and the agricultural sector are contending with higher operational costs, including for fertilizers and farm equipment. That could keep grain prices elevated in 2023. Grains tend to trade at or near their cost of production, but historically seldom trade below production cost. Prices for fertilizer components such as urea have pulled back from record highs in 2022 but remain well above the five-year average. Prices for natural gas, another raw material for fertilizer, have fallen sharply over the past month, but they are also up from a year ago.

A change in the financial climate has already hit the technology sector, letting the air out of the bubble in growth stocks. This could be compounded if an economic downturn follows in 2023, turning a sharp valuation adjustment into a broad-based rout in the tech industry. Many tech companies have already been struggling to deal with the aftermath of the recent boom, by cutting workers and paring back investments. An economic crunch that also hit demand for their products and services would force many companies to much deeper cuts and threaten the post-covid hangover into an outright tech depression.

The real estate and construction sectors are recalibrating as the long era of cheap money, which has drawn so many new investors into those sectors since the financial crisis, comes to a halt. Owners of offices, shops, warehouses around the world were still figuring out what impact the pandemic has had on their tenants when they were hit by rising interest rates in 2022. Higher borrowing costs, inflation and the threat of recession will push some landlords to the brink in 2023, and the expectation is that forced sales will begin in earnest within the first half of the year, as property owners have to refinance loans at far higher rates or sell assets to meet redemption requests from investors.

Global economic growth is forecast to slow from 6% in 2021 to 3.1% in 2022 and 2.7% in 2023. This is the weakest growth profile since 2001 and during the acute phase of the Covid-19 pandemic.

Eurozone

A resilient Germany is weathering the energy crunch. German inflation slowed more than expected in December, sliding into single digits for the first time since last summer and providing some relief for the European Central Bank [ECB] in its battle to control price increases. Consumer price inflation fell to 9.6% in December, well down on the 11.3% registered in November.

The eurozone’s largest economy is the latest country to experience a sharper than expected fall in price pressures. The German number, down from a seven-decade peak of 11.6% in October – follows a sharp fall in inflation in Spain and may ease pressure on the ECB, which will next meet to set rates on February 2, 2023.

Together, the German and Spanish figures suggest eurozone inflation could drop lower than the 9.7% forecast by economists. According to the Institute of International Finance, a trade body for global finance, the fall in inflation means that the peak of ECB hawkishness is behind us. Headline inflation in Germany seems to have reached its peak and unless there is another large surge in energy prices, double digit inflation numbers should be gone for some time. However, some caution is appropriate as the nature of the sharp decline is in part driven by the government’s gas price support subsidies. Nonetheless, the ECB is still on course to raise rates a few more times this year.

German headline inflation is still likely to continue to decline further in the months ahead. Separate data from the German Labor Office showed unemployment declined to 5.5%. The robustness of the country’s labor market is expected to bolster the ECB’s view that the eurozone recession is set to be shallow and that underlying price pressures remain too strong to stop the tightening cycle at this time.

European natural gas prices have fallen to levels last recorded before the Russian invasion of Ukraine last February, as warmer weather helps to preserve reserves.

The Dutch gas futures for January, the benchmark European contract, dropped to its lowest levels in ten months. Russia’s weaponizing of the commodities it sells to Europe, combined with record-breaking temperatures, helped push gas prices to more than $500 per metric unit over the summer. In an effort to stem prices, the EU has implemented a series of measures including mandatory gas storage and consumption reduction targets.

The latest price decline comes from warmer than usual temperatures across north-west Europe, which are expected to linger for a while. As the warm weather reduces heating demand, Europe has been able to build up its gas inventory again after drawdowns from mid-November, including during cold snaps in December.

Since Christmas Eve, Europe has been sending more gas into its storage facilities than it has taken out of them, with storage levels increasing. Capacity stood at 82.2% as of year-end, down from the mid-November high of 95.6% , according to the industry body, Gas Infrastructure Europe. The current level is 30% higher than the same period last year, when Europe had unusually low levels of storage, and about 10% higher than the average of the previous five years. Reduced demand for gas has also helped inventories, with the region cutting its requirements by about a quarter compared with the five-year average.

Analysts warn that Europe will be in a difficult position when trying to restock its gas inventory next winter, when the volume of gas supplied from Russian pipelines will be considerably lower and liquified natural gas market, which the region has depended on this year, remains tight.

Weakened demand in China, the world’s leading grain consumer, will likely affect the outlook for agricultural futures in 2023. With the Chinese authorities having now reversed previous Covid lockdown protocols, Chinese companies, factories, and traders are seeking to step up economic activity. However, that could take months. The consensus is for an economic turnaround in China to pick-up pace late in 2023, once the current outbreak of the Omicron variant has subsided.

In a change of course, China’s pandemic controls that included relentless lockdowns, mass testing, quarantine and electronic contact tracing have been rapidly dismantled. The toll those policies had on the economy are many. Meanwhile, the sudden abandonment of the zero-Covid playbook has led to an alarming spike in new Covid-19 infections and, according to some forecasts, could lead to millions of deaths over the winter. For the next several months the impact on Chinese growth will be negative, the impact on the region will be negative and the impact on global growth will also be negative, according to the IMF.

Before the recent sudden reopening of society, Chinese doctors and nurses warned that the country was unprepared for a new Covid wave, given thinly resourced hospitals and medical clinics, and nearly 90 million Chinese aged 60 and over – who had not received three vaccine doses. Now, China’s healthcare system is being overwhelmed with a deluge of sick patients, and funeral providers are unable to keep up with demand for their services.

Beyond the immediate health crisis, which could persist for months, the true extent of the damage wrought upon Chinese society by the Administration’s zero-covid policies is only just emerging. For large swaths of the 1.4 billion population, the pandemic shattered the fragile balance that once supported the back-and-forth movement of people from rural areas to cities. Zero-covid’s vast web of intersecting restrictions hammered low-income families, and in some cases, left people cut-off from their loved ones.

As the restrictions have been unwound, it is becoming clear that the pandemic’s scars are deepest among youngsters in rural areas, experts say. Rising inequality, which is heavily influenced by access to education, could in the coming years carry repercussions for the Chinese leadership and the ruling Chinese Communist Party. In addition, China’s youth unemployment rate has been near-record levels and the brunt of the impact is shouldered by those born to poorer households. At the height of the nationwide lockdowns in 2020, the UN estimated that 1.5 billion school children globally were affected by school closures, a third of which did not have access to remote learning facilities. However, the problem facing China’s 291 million students stand out because of just how long Beijing persisted in using lockdowns to try to contain the virus. Weak test results show how much learning has deteriorated among students in rural provinces. Teachers in China report a decline in the quality of students’ ability overall since the pandemic.

One negative effect that is little discussed but may have longer-term implications is education. as it has sharpened China’s already high levels of social inequality, especially between urban and rural residents. Many young people from rural areas or the urban lower classes have been forced to study online and have been separated from their parents for long periods over the past three years. The result is that their education -hitherto their only path to upward mobility- hangs in the balance.

Despite the dangers inherent in public displays of dissent, frustrations among younger Chinese and opposition to the policies of the current rulers, have become increasingly evident in recent months. The sudden reversal in China’s Covid lockdown policies, came on the heels of recent national street protests and demonstrations. An Australian think-tank has tracked more than 100 protests and acts of public resistance across 39 cities across China. Some Chinese experts believe that the legacy of the 2022 protests will go far beyond the zero-Covid policy reversal. The current period marks a turning point for a generation who have no memory or knowledge of the 1989 Tiananmen democracy movement. Prior to the protests, Chinese citizens had largely complied with the zero-Covid policy as citizens under any authoritarian system would. However, last year’s protests showed that not all Chinese people feel the authorities are infallible, and some are daring to dissent for the first time. Other experts point to the credibility of President Xi Jinping’s being badly wounded as Covid death toll mounts. There is also a sense of exhaustion among much of China’s middle class, dashing hopes of an economic recovery based on pent-up consumer demand. Despite official forecasts promoting an early economic turnaround, some economists refuse from ruling out a long phase of stagnation to hit the Chinese economy. This remains the biggest uncertainty for many observers.

The transition back to normal life is proving difficult. There is a sense of euphoria that restrictions are being lifted but fears remain. Central shopping districts in many big cities appear empty during the day. Over the three-day public holiday around January 1st, the number of domestic trips was barely higher than a year earlier, and less than 45% of the pre-pandemic figure. At cinemas, sales were down nearly 46%. However, reports of a pick-up in nightlife is encouraging with images of packed bars and crowds of new year revelers in cities across the country have circulated on Chinese social media. While the disease spreads, it will be hard to keep production lines running and haulage trucks on the road. Covid is also ripping through factory towns and causing serious disruption. Local governments and company managers are battling high infection rates on factory floors. In late December suppliers in major exporting provinces such as Guangdong, Zhejiang, Shandong, and Jiangsu faced severe delays. Many home appliance makers, for example, were operating at 20%-50% capacity.

Another worry is that workers could be forced to quit to take care of elderly family members living far from the factories. As China proceeds with its flash exit from zero-covid, manufacturing hubs could experience some short-term shocks to labor supply, as workers head home earlier than expected for their Chinese New Year break. They may also delay their return.

Local government intervention may also pose a risk to business. Some executives worry that as cases surge, officials could begin to seal off their towns. Even within towns, traffic from one district to another might be restricted. That would interrupt the connectivity that makes Chinese cities so efficient for manufacturers. Predicting how long such disruptions may last is difficult.

Egypt

The Egyptian pound plunged to a record low early in the New Year, the latest sign of the country’s severe foreign currency crunch, two months after agreeing to a $3 billion rescue loan from the IMF. This is the fourth time in six years that Egypt has had to resort to the IMF.

The currency fell 6% to 26.4 to the U.S. dollar – the steepest slide since the Central Bank of Egypt (CBE) in late October devalued the pound in an effort to clinch the IMF deal. The recent slide comes as billions of dollars of imports are blocked in Egyptian ports because local banks are unable to secure enough dollars to pay for them due to the shortage of foreign currency. This has left importers stranded for badly needed parts, manufacturing inputs, raw materials, consumer goods, etc.

Russia’s invasion of Ukraine in February 2022 spurred outflows of $20 billion from Egypt- in a flight to safety by foreign debt investors. The war also caused prices of raw materials to soar, dealing a powerful blow to Egypt, the world’s biggest importer of wheat. In an effort to conserve foreign currency, the CBE placed restrictions on imports last March. The requirement to use letters of credit, or Documentary Credit, slowed the process and created a backlog of unfulfilled demand for dollars. It also prioritized access, placing basic commodities such as food staples and medicines at the top of the list.

The new IMF pact includes a requirement that Egypt implement a permanent shift to a flexible exchange rate regime instead of using foreign currency reserves to keep the exchange rate at a targeted level. This way, market forces would determine the currency’s value- something Egyptian governments have long resisted. The CBE devalued the pound in March 2022, and then again in October, with the currency losing 40% of its value against the dollar over the period. The two devaluations reduced the pound from around 16:U.S.$1, to 24.7:U.S.$1. The CBE increased interest rates by 300 basis points on December 22, taking the overnight deposit rate to 16.25%. The rise surprised expectations and reflects increasing concern about inflation, the falling pound, as well as the need for Egypt to attract foreign portfolio investors back (with these higher interest rates).

It is unclear if the recent fall in the currency exchange rate in early January, represented the expected move to a flexible exchange rate regime. To determine that, we will need to monitor the level at which the currency will eventually stabilize, the extent to which this will lead to improved foreign currency liquidity in banks and if we see more volatility in the pound going forward.

Last year, the CBE revoked the need for importers to use letters of credit, a measure that was initially introduced in March in order to conserve scarce foreign currency resources by slowing down the import process. Successive Egyptian governments have been reluctant to move to a flexible exchange rate to avoid big jumps in prices in a country reliant on imports for many of its basic needs. But the scarcity of foreign currency in recent months and the emergence of a parallel market in dollars had already stoked inflation to 18.7% in November, its highest level in five years.

In December, the CBE boosted interest by three percentage points in an attempt to cool down inflation. State-owned banks early in January began offering one-year deposit certificates at a 25% interest rate- a move aimed at enticing savers to hold on to their Egyptian pounds rather than convert them to dollars.

Businesses from poultry farmers to car manufacturers have been badly hit in a country that imports most of its food and many of the inputs for its industries. As policymakers ponder when and how to move to a flexible exchange rate regime where the value of the pound is not propped by the CBE, entrepreneurs complain they have no visibility on the future.

Importers will be watching to see if dollars will be available to clear the backlog of imports stuck in ports, which equated to about $9.5 billion, this according to the Prime Minister. These include goods ranging from corn and soya, used as animal feed, to cars, industrial inputs, and household appliances. Importers in a variety of sectors were all caught up in the predicament: how to secure foreign exchange to pay for necessary inputs needed to run their businesses. Car parts, corn, soya, among other essential goods, remain stuck at the ports. Some poultry farmers have had to kill chicks. The result a substantially lower supply of chickens being sold causing prices to increase more than 50% last year. That example is applicable across a variety of sectors in Egypt.

Despite $13 billion in deposits from the United Arab Emirates, Saudi Arabia, and Qatar and another $3.3 billion in asset sales to the UAE in 2022, foreign currency has remained in desperately short supply for this import-dependent country. In late December President Abdel Fattah al-Sisi commented that banks would secure foreign exchange necessary to clear the backlog of imports within four days. He didn’t say from what source.

Concerns have lingered about the Egyptian authorities commitment to a flexible exchange rate, but developments over the past week suggest that they may be moving in the right direction. However, Cairo based investment bankers stress that the shift to a flexible exchange rate system cannot happen overnight. Instead, the authorities need to first build up a buffer of foreign currency to help clear the backlog of demand, before moving on the exchange rate.

As policymakers weigh the options, the outlook for many Egyptian businesses is uncertain. One multinational auto components company suggested that his business had fared better in the environment than most it was also an exporter, giving it access to foreign currency. However, those reserves are being depleted and the company is now unsure whether to accept new orders. The company is unsure if it will be able to clear imported inputs for a new order and have to pay thousands in holding fees as it waits for dollars from the banking system.

Brazil

Brazil’s fortunes have risen and fallen since Lula da Silva [Lula] was last president. As President once again (effective January 1, 2023) Lula has a daunting task ahead because of Brazil’s many economic challenges. Big pre-election spending helped boost GDP growth last year 2.9%. But growth is expected fall to 1% in 2023. Meanwhile, inflation is down from a peak of 12% in April to 6% in November. However, the share of Brazilians who do not get enough to eat has risen from 6% four years ago to 16% today.

The outgoing Bolsonaro administration succeeded in putting the state pensions system on a sounder footing; but failed to realize many of his promised liberal economic reforms. Inflation has helped to reduce the burden of government debt, by swelling the size of national income. But high inflation has also pushed up the government borrowing costs and eroded confidence in long-run macroeconomic stability. This leaves the new Lula government with less room to maneuver in dealing with the federal debt burden, which at 75% of GDP, remains uncomfortably high.

The resulting fiscal crunch will complicate Lula’s ambitious policy plans and the speed with which he hopes to enact them. He wants to revamp various social policies started under his earlier administrations. These include a conditional cash-transfer scheme known as Family Fund, a subsidized-housing initiative, and a program to provide jobs and upgrade Brazil’s shoddy infrastructure.

Lula also plans to reduce illegal deforestation of the Amazon. The pace of tree clearing in the Amazon rose 60% under former President Bolsonaro as officials turned a blind eye to illegal logging, mining, and land grabbing. Among Lula’s first decrees upon taking office were ones to restructure environmental bodies gutted by his predecessor, reverse plans to legalizing wildcat mining in protected areas and reactivate the Amazon Fund, by which Norway and Germany help pay for environmental policing and sustainable-development projects.

Lula has had to scramble to fill a hole in the budget for 2023 of the order of 1.7% of GDP. By rallying support in Congress for a constitutional amendment to exclude roughly that amount from a federal spending cap. Lula’s amendment passed. This was not easy, despite his reputation as a skilled negotiator. Lula’s Workers Party (PT) has a minority position of just 12 seats in congress.

Faster growth than Brazil’s lackluster 0.5% annual average of the past decade is crucial to fund social programs on the new governments platform. Financial markets will not be tolerant with leftist-like overreach or state interventionism that undercuts private initiatives, stifles competition or the ability of markets to function relatively free. Brazil’s economic turn around will depend on such assurances.

The new Lula administration is off to a bumpy start with supporters of former President Bolsonaro having violently attacked the parliament and supreme court and rioted against police trying to protect these institutions. Opposition forces has sent a clear message that its tactics won’t be limited to debates in Congress.

Nigeria

The end of 2022 coincides with the twilight of President Muhammadu Buhari’s second term in Nigeria. After coming to power seven years ago promising to rein in corruption, create jobs, and alleviate poverty, its hard to find evidence that much has changed.

While GDP growth was officially reported at 3.1% in 2022, inflation at 16% at the beginning of 2022 rose to a peak of 21.5% in November. Meanwhile, food inflation consistently outpaced headline and core inflation during the year. For the basket of goods consumed by the average Nigerian, costs accelerated by between 50% to 100% in 2022. According to the World Bank [WB] approximately five million Nigerians were pushed into poverty in 2022 amid a slump of purchasing power by 35% driven mostly by inflation.

The impact of inflation squeeze on small and medium sized enterprises (SME’s) was also devastating. The foreign exchange challenge was a major restraint for investors and importers in Nigeria during 2022. Sharp currency depreciation, foreign exchange illiquidity, especially at the official window; volatility of the exchange rate, created considerable uncertainty and unpredictability for importers, investors and widened transparency issues in the FX allocation system. According to the WB, while the official exchange rate depreciated by 5.2% in 2022, the parallel market rate depreciated by 40%. The WB concluded that Nigeria’s exchange rate policy settings are stifling business activities, investment, and growth, thereby amplifying the country’s macroeconomic risks.

Foreign exchange reserves were down at $36.97 billion at yearend 2022 from $40.04 billion in December 2021. The decline was due to lower prices, sub-optimal oil production and the central bank’s futile efforts to support the currency. The FX reserves are unlikely to increase over the short-term due to the country’s inability to benefit from high oil prices due to oil theft as well as the central bank’s efforts to stabilize the Nigerian naira. Rationing and restrictions in the foreign exchange market by the central bank and further widen the gap between the official exchange rate and the parallel market rate as demand pressure rises.

While GDP growth is projected at 2.9% for 2023 the FX situation is unlikely to improve much this year. Shipping is crucial to the Nigerian economy and the need for reforms have become urgent. These include the pressing priority of reducing delays in clearing cargo from arriving vessels, removing bureaucracy and red tape, curbing extortions in the clearance of vessels. The aim is to reduce vessel turnaround time from the current 20+ days to less than one week.

Last year the central bank launched a scheme to attract $200 billion in foreign exchange repatriation from non-oil exports over the next three years. The scheme emerged out of the need to diversify Nigeria’s export earnings from oil while addressing declining FX earnings. The central bank admits that, so far, its efforts recorded 44.98 billion in FX inflows. Cocoa beans, sesamum seeds, cashew, and seven others top the list of agricultural commodities Nigeria exported in 2022, generating $1.7 billion in revenue in nine months, according to latest data from the National Bureau of Statistics. On a year-on-year basis, the value of the top agricultural exports increased 14.9% in 2022 over 2021.

To unlock growth and investment in 2023, the government will be forced to undertake some urgent reforms. The enactment of the Petroleum Industry Act (PIA) promises to transform the oil sector through the creation of a legal and regulatory framework meant to inspire higher levels of investors’ confidence. However, Nigeria needs to demonstrate a greater commitment to the implementation of the PIA. For example, the deregulation of the petroleum downstream sector is a major economic reform imperative that markets are expecting; and which would indicate a good faith commitment to changes in the business climate. This will be an important first step to unlock investment in the sector and put an end to the perennial fuel scarcity and the monopolistic structure of the sector over generations.

There is also a need to consolidate reform in the ailing power generation sector. Businesses and households alike continue to highlight the need to enable and create an environment that will sustain private sector investment in the sector; and attract new private capital to boost electric generating capacity. This has become a national rallying cry. Urgent reforms are needed with respect to electricity tariffs, metering and deepening the energy mix. Nigeria needs fiscal and monetary incentives to boost private investment in renewable energy. It must seek every opportunity to achieve this goal in the not too distant future.

Uruguay

This country’s president Luis Lacalle Pou has been hard at work negotiating new trade deals outside the regional trade block since taking office in March 2020. Mr. Lacalle Pou’s ambitions are running up against other Mercosur members who are closing ranks on Uruguay, as political alliances shift in the region. The Uruguayan president has decided to “open up to the world” under his pro-business platform.

The tensions of such a move were on display in December at the Mercosur summit held in the Uruguayan capital Montevideo. There were accusations of foul play and unsportsmanlike tactics on news that Uruguay has independently applied to join the Trans-Pacific Partnership [TPP], the 11-member trade alliance including Australia and Japan. This followed separate bilateral trade talks with China and Turkey earlier last year.

The Argentine Foreign Minister admonished Uruguay to choose if its with Mercosur. The Argentine’s claim that any member of Mercosur determines something without consensus, it is breaking the fundamental rules of Mercosur. Together with Argentina, Brazil, and Paraguay, Uruguay makes up the Mercosur partnership, a three-decades-old customs union in which no individual country is allowed to negotiate preferential agreements with third parties.

Many trade observers have described the protectionist alliance of Mercosur as one of the least effective of its kind anywhere in the world, both in terms of trade among its members and with external partners. It has also struggled to finalize a free trade agreement with the EU, a process that is entering its 24th year.

Those delays and frustrations are among the factors driving Uruguay’s mission to explore opening up to foreign markets on its own. According to president Lacalle Pou Mercosur can no longer lead with an early 1990’s mindset or pull back on any member’s economic progress.

Chile, Colombia, Peru, and Mexico have all been looking towards the Pacific to expand trade with Asia. All have joined the TPP, with the exception of Colombia, while Mercosur has stalled.

The other three Mercosur member states have called for regional unity, threatening to penalize Uruguay with a series of undisclosed measures if it continues to pursue commercial arrangements alone. Critics regard the threats as bullying against a smaller country because it has triggered real discussions about restructuring the alliance, which could ultimately lead to a break-up. Argentina and Brazil account for nearly 90% of the trade block’s GDP, giving them more influence in negotiations. Some say the bigger countries simply use Mercosur as a trade shield, to protect their industries from global competition.

Uruguay maintains that the country wants to modernize, not cut away from the block, that represented roughly a third of overall Uruguayan trade in 2022.

The president has defended his nation’s actions., arguing that a decision to lower the common external tariff applied to goods from outside the block in September 2022, between Brazil and Argentina was made without consensus among partners. Recently the Uruguay-China chamber of Commerce reiterated its support for the steps taken by the Uruguayan government to deepen trade relations between the two countries, saying that advancing the Free Trade Agreement with China was central to their strategy.

Outgoing Brazilian leader Jair Bolsonaro pledged support for Uruguay’s attempts to make Mercosur more flexible. However, Bolsonaro successor Lula may have other ideas. Lula has already emphasized that greater Latin American integration and multilateralism will be critical to his administration’s foreign policy. Lula’s new term in office marks the first time in four years that the biggest members of Mercosur, Brazil, and Argentina, are politically aligned under the direction of leftist leaders.

Uruguay’s move to go ahead with its own international deals was a risky given the heightened political uncertainty. They don’t know what Brazil will do under Lula. And what Brasilia says matters more that Argentina. Because of Uruguay’s diplomatic power many do not believe the country will be thrown out of Mercosur or penalized.

Lula is himself strongly in favor of bolstering trade, in particular with China, which remains Brazil’s biggest buyer. In Lula’s previous two terms as president in the early 2000’s, Brazil became a member of the BRIC’s block with Russia, India, and China, which became an important tool for global cooperation. It is now up to Lacalle to convince Lula to lead the China negotiations for Mercosur.

By Byron Shoulton, FCIA’s International Economist For questions / comments please contact Byron at bshoulton@fcia.com

Since 2004, Securitas Global Risk Solutions, LLC (“Securitas”) has helped clients develop credit and political risk transfer solutions that provides value on numerous levels.  As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service.

Carlyle Aviation Partners’ lawsuit against insurers

Carlyle Aviation Partners LLS v. American International Group UK was filed in the 11th Judicial Circuit, Miami-Dade County, Florida on October 31, 2022. In it, Carlyle Aviation Partners and its affiliates are suing over 30 insurers and reinsurers for not indemnifying it for a $700 million claim on confiscated jets.

Summary

After Russia invaded Ukraine in February 2022, a flurry of sanctions was placed on Russia and vice-versa. Carlyle Aviation Partners, an American Company and one of the world’s largest aircraft leasing operators, has lost use of 23 jets as a result. Carlyle has an insurance policy on these planes, which permits it to claim $225 million for damages to any one plane, with a $700 million coverage limit. Carlyle filed an insurance claim for over $700 million with over 30 insurers to cover the loss of the jets. Now, it is suing for unspecified damages, to be determined in court. The lawsuit was filed on October 31 and alleges that their insurers have failed to meet their contractual obligations to cover Carlyle’s loss of the 23 aircraft. A special hearing on the case is scheduled for March 10, 2023.

When Russia invaded Ukraine, Carlyle asked the Russian airline lessees to return the 23 aircraft and terminate the leases. The Russian airlines said that they would not be able to return the aircraft due to restrictions from the Russian Government. The Russian Government had prohibited foreign-owned aircraft from a list of “unfriendly” countries from flying out of the country without a special permit. This list included the United States, the European Union, the United Kingdom and Commonwealth, and Switzerland. Carlyle says in its complaint that it took “all reasonable steps to protect, preserve, and recover these insured assets [the aircraft].” The aircraft remain in Russia, except for one that is in Egypt. However, Egyptian authorities said that they would return the aircraft only if Carlyle paid outstanding parking and storage fees. There were 515 aircraft from foreign lessors in Russia when sanctions were enacted against Russia.

Carlyle Aviation is not the only aircraft lessor filing insurance claims over Russia’s actions. Insurance companies now face multiple multi-million and billion-dollar claims stemming from Russia’s confiscation of aircraft. AerCap Holdings NV, the world’s largest aircraft-leasing firm, also filed claims for $3.5 billion related to Russia confiscating its jets. SMBC Aviation Capital, the world’s second largest aircraft lessor filed a claim in November against Lloyds of London on $1.6 billion of aircraft losses in Russia. Dubai Aerospace Enterprise, the largest plane-leasing firm in the Middle East,  filed a $1 billion insurance claim in May for aircraft held in Russia. This amount is expected to rise, though.

The lawsuit

• Carlyle Aviation Partners filed a claim against 30 insurers for $700 million for the Russian government’s confiscation of 23 of its jets.
• The named insurers include American International Group UK, Chubb European Group SE, and Berkshire Hathaway International Insurance Ltd.”
• Now, Carlyle Aviation seeks unspecified damages, to be determined at trial.
• Carlyle alleges nine separate breaches of contract and violation of “good faith duties.”
• Russia has enacted other policies prohibiting the return of the aircraft. Carlyle Aviation notes Russia’s blanket prohibition on the return of aircraft in its complaint, saying that “on March 8 and March 9, the Russian government banned the export or relocation of aircraft, aircraft engines and other components until December 31, 2022.
• Carlyle’s attorneys are basing much of their legal argument on the policy’s hull coverage. However, hull coverage is usually limited to coverage of damages to the plane, excluding losses from wear and tear, hijacking, and government action.

The seizure

• Carlyle Aviation leased the 23 planes to 12 different Russian airlines, including Izhavia, NordStar, Smartavia, and UTair, the country’s sixth-largest airline in 2021.
• Carlyle requested the return of the aircraft on February 27, three days after Russia’s invasion of Ukraine began on Feb. 24, the company said in its complaint.
• The airlines  told Carlyle Aviation that they could not move the aircraft out of the country, due to airspace restrictions and closures. According to the complaint, these restrictions prohibited flights from  thirty-six countries that included all EU member states, the United States, the United Kingdom, part of the Commonwealth, Canada, and Switzerland. Any of these flights are required to get  special permits.
• The Russian airlines that the planes were leased to have ignored Carlyle Aviation’s demand to return the aircraft.
• Carlyle Aviation Partners said that it was bringing the lawsuit because it has “exhausted all avenues to recover the aircraft.” It says that it has followed all required procedures and has not been indemnified.
• The aircraft remain in Russia, except for one Boeing 737-800 that is being held in Egypt. However, the Egyptian authorities said that they will only return the jet if Carlyle pays outstanding parking and storage fees.

Other aircraft lessors

• Russia seized a total of 515 planes from overseas companies, worth about $10 billion.
• According to Bloomberg, “Dubai Aerospace Enterprise, the largest plane-leasing firm in the Middle East, booked a $576.5 million write-off for planes leased to Russian airlines in August and filed an insurance claim.
• In March, AerCap Holdings NV, the world’s largest aircraft-leasing firm, filed $3.5 billion in claims from insurers related to jets and engines that are being held in Russia.
• Irish-headquartered SMBC Aviation Capital, the world’s second largest aircraft lessor by number of aircraft, recorded a $1.6 billion impairment earlier this year, and filed a claim against Lloyds of London in late November.
• Fitch Ratings estimated in March that claims tied to the conflict may eventually total $10 billion—the most in the history of aviation insurance . However, Lloyd’s of London disputes this total.

The policy’s exclusions for war

Carlyle’s policy does not cover claims caused by

• War, invasion, acts of foreign enemies, hostilities (whether war be declared or not), civil war, rebellion, revolution, insurrection, martial law, military or usurped power or attempts at usurpation of power.
• Any hostile detonation of any weapon of war employing atomic or nuclear fission and/or fusion or other like reaction or radioactive force or matter.
• Strikes, riots, civil commotions or labour disturbances.
• Any act of one or more persons, whether or not agents of a sovereign Power, for political or terrorist purposes and whether the loss or damage resulting therefrom is accidental or intentional.
• Any malicious act or act of sabotage.
• Confiscation, nationalization, seizure, restraint, detention, appropriation, requisition for title or use by or under the order of any Government (whether civil military or de facto) or public or local authority.
• Hi-jacking or any unlawful seizure or wrongful exercise of control of the Aircraft or crew in Flight (including any attempt at such seizure or control) made by any person or persons on board the Aircraft acting without the consent of the Insured/Operator.

Furthermore, this Policy does not cover claims arising whilst the Aircraft is outside the control of the Insured/Operator by reason of any of the above perils.  The Aircraft shall be deemed to have been restored to the control of the Insured/Operator on the safe return of the Aircraft to the Insured/Operator at an airfield not excluded by the geographical limits of this Policy, and entirely suitable for the operation of the Aircraft (such safe return shall require that the Aircraft be parked with engines shut down and under no duress).

Political risk insurance

In political risk insurance, the insurer commits to indemnifying the insured for a percentage of losses from an expropriatory act.  This act includes expropriation, confiscation, nationalization, requisition, and sequestration.

The act must be taken by, or under the order of, the host government in which the foreign enterprise is located. The act must also:

• Permanently deprive the Insured of all or part of its equity ownership interest in the foreign enterprise
• Permanently deprive the foreign enterprise of all or part of the applicable physical property or
• Selectively prohibit or materially impair the operation of the foreign enterprise so as to cause the permanent and total cessation of its activities

Importance of insurance brokers

Insurance policies need to be carefully tailored to the needs of the insured. A well-crafted, comprehensive policy can prevent the kind of claim disputes that Carlyle Aviation is having. Brokers walk you through getting the right coverage for your assets, advocate for you, and handle the details of your claims.

Securitas

Since 2004, Securitas Global Risk Solutions has helped clients develop credit and political risk solutions. Securitas is focused on developing comprehensive solutions that meet the needs of our clients. Please feel free to call us with any questions, or if we can be of any assistance.