Country Risk Trend March 2008

Recent full-year forecasts have tended to be more pessimistic than those made late last year. The United States' GDP growth has been revised to 1.5 per cent for 2008 down from 2.2 per cent in 2007. Although still expected to manage only very weak even negative growth in the first half, the American economy should strengthen later in the year thanks to the reactivity of economic policy measures and a positive contribution from foreign trade spurred by the dollar decline and continuing dynamic demand from emerging countries (50 per cent of American export sales).

Euro-zone growth should also be down nearly a point in 2008 settling at 1.8 per cent for the year with exports undermined by the euro appreciation and domestic demand likely to be affected by the property market downturns in some countries and the general tightening of credit. The outlook is also gloomier in the United Kingdom and Japan with growth expected to slow substantially, down respectively to 1.9 and 1.4 per cent in 2008.

And the more pronounced slowdowns thus expected in industrialised countries should affect emerging economies, which will lose a point of growth overall and expand 6.2 per cent on average this year compared to 7.2 per cent in 2007. Asia, Latin American, and Emerging Europe will take the brunt of the slowdown. The negative effects on trade resulting from the industrialised-country slowdown will be compounded by the prospective adoption of more restrictive monetary policy to check a resurgence of inflation. Rising raw material prices should, however, keep economic growth at high levels in Africa and the Middle East.

In total we foresee world growth slightly above three per cent against four per cent in 2007. Remember that in 2001, world growth was only 1.5 per cent with the American economy up a mere 0.8°per cent including two non-consecutive quarters of GDP decline and with emerging economies up "just" 3.0 per cent.

A more sombre scenario than the one described here is becoming increasingly probable and is thus worthy of attention: the risk that the American economy will remain sluggish in the second half with the economic policy measures taken not sufficing to restore confidence in the financial system and a credit rationing thus developing on a large scale. The American economy could thus shrink 0.5 per cent for the full years and in that case the repercussions on the rest of the world, especially emerging countries, would be more pronounced. Besides regular trade channels, confidence would be undermined by a delayed emergence from the crisis and that would particularly affect the domestic demand underpinning the staying-power of emerging countries in the main scenario. Although emerging economies would doubtless still manage to grow at a quite respectable 4.2 per cent rate that would not suffice to maintain world economic growth above 2.0 per cent.
The euro zone would also suffer a more marked slowdown. By comparison, while the United States economy went into a tailspin in 2001 the euro zone maintained growth of 1.7 per cent. The crisis effects were, however, more spread out over time in Europe. The euro zone managed only 0.9 and 0.8 per cent growth respectively in 2002 and 2003 while the United States rebounded to 1.6 and 1.7 those same years. This second scenario, with world growth limited to two per cent, constitutes a second credible but nonetheless less likely hypothesis that the main scenario.

The increase in risks associated with world economic conditions is primarily attributable to the exacerbation of the financial crisis epitomised by the near bankruptcy of Bear Stearns (fifth largest American investment bank) and its eleventh-hour takeover by JP Morgan on 17 March in cooperation with the Fed. Besides the destabilising influence that such an event can have on financial markets, the main risk is that it tends to intensify the credit crunch. It is still too early to know whether we are witnessing "only" a credit slowdown — with an increase in lending rates and an increasingly strict selection of borrowers — or an actual rationing process with a sharp decline in the supply of credit. Central bank surveys (by the Fed and ECB) reflect expectations for a sharp tightening of credit conditions.

The figures available at this juncture — limited to 2007 — do not, however, reflect a credit crunch: total bank credit to households and companies grew at a nominal 11 per cent rate in Europe and the United States in 2007. But it seems that credit may have reached a cyclical peak with growth rates even higher — as regards lending to companies — than they were in 2000 (20 per cent last year compared to 12 per cent eight years ago). On a quarterly basis credit extended to companies has nonetheless begun to slow markedly since the 2007 third quarter in the United States with the 40 per cent growth posted at mid-year falling to 20 per cent on average for the year. From a macroeconomic perspective, corporate debt in the United States, representing 40 per cent of GDP, is slightly below its level in 2001 with companies boasting good self financing ratios, about 88 per cent on average.

A comparison with bank credit trends in 2001 is hardly reassuring:





North America

United States
A1 rating negative watchlisted since April 2007
Downgrade from A1 to A2

Reasons for the negative rating change: Revised down to 1.5°per°cent for the year, economic growth should be flat in the first half affected by a greater-than-expected slowdown of household consumption (70 per cent of GDP). That reflects an erosion of household confidence attributable to several factors notably including a gloomy job picture, a negative wealth effect caused by declining property and financial asset values, higher prices for food and for petrol at the pump, and increasingly difficult mortgage refinancing conditions. Residential construction, and now the non-residential component continue fall amid tighter credit conditions. Companies have been delaying their investments. Filings for bankruptcy and Chapter 11 protection have increased, a trend borne out by the deterioration in the corporate payment experience registered by Coface since last fall. The stiffer conditions for obtaining bank credit have particularly affected companies with the highest debt, notably in connection with debt-leveraged transactions. The weakest sectors include construction and those associated with domestic consumption.

The subprime property crisis and the tighter conditions of access to credit applicable to both households and companies have been spreading to the real economy since late last year. Growth will slow in 2008 (up1.5 per cent) and may even be negative during a particularly morose first half before improving later in the year at a time when an easing of monetary policy (300-basis point interest rate cuts between September) coupled with a fiscal package representing one per cent of the federal budget could begin to have an effect on the economy.

Households, whose consumption represents 70 per cent of GDP, will continue to significantly reducing particularly through deep cuts in discretionary spending. Their confidence is eroded by the continuing depreciation of their property and financial wealth, a shrinking job market, rising unemployment, and the decline in their disposable income affected by the increasing cost of foodstuffs and petrol at the pump. With limited savings and very high debt representing 135 per cent of their disposable income, they have to contend with tighter mortgage refinancing conditions. The fiscal stimulus should not be very effective in mitigating the household consumption slowdown. Rather than spending on consumer goods, households may prefer to devote the amount of the cheque they receive in May to building savings or paying past due bills.

The continuing decline of residential construction — down 21 per cent — will also affect growth with building permits down 36 per cent for the year ending in February this year, new housing starts down by over 28 per cent, sales by 27 per cent, and the median price 15 down per cent. And the crisis has spread in turn to non-residential construction with companies postponing investments in corporate structures amid the tight credit conditions. Bolstered, however, by a low rate of indebtedness overall — 43 per cent of GDP — and sound cash flow ratios (88 per cent on average), companies should continue their capital spending despite the gradual erosion of return on capital (9.3 per cent of GDP). Corporate investment growth should not exceed 2.8 per cent.

Exports (12 per cent of GDP) continue to grow at a satisfactory pace thanks to both favourable exchange rates to the United Kingdom, Canada, and the European Union and the unabated economic dynamism in emerging regions, which absorb 50per cent of sales abroad, particularly China and the Middle East. With imports stalled, meanwhile, amid the slowdown of domestic consumption, foreign trade should thus make a slightly positive contribution to growth.

The economic slowdown has affected corporate payment behaviour. According to the private AACER organisation, the significant increase in companies in liquidation or under Chapter 11 protection, up respectively 43 and 25 per cent, should continue this year.

That trend has already resulted in deterioration of the Coface corporate payment experience mainly on companies in sectors linked to domestic consumption. The rising cost of energy, transport, and some inputs has put pressure on their margins and the credit crunch has exacerbated their already shaky financial health. That has of course affected not only residential construction — including home developers and builders, manufacturers and distributors of home furnishings and construction materials, financial intermediaries and institutions, and so on — but also car manufacturing and home-related retailing. Services to private individuals and leisure (restaurants, hotels, travel), along with the textile-clothing and Hi Fi-TV-video sectors have also suffered from the belt-tightening by households.

The United States' economic difficulties have begun to affect neighbouring Canada and Mexico with their ratings negative watchlisted as a result.


Canada
A1 rating
Negative watchlist on the A1 rating

Reasons for the negative watchlist status: Increased payment incident risk in the manufacturing industry prompted the negative watchlisting of Canada's A1 rating. Already faced with the Canadian dollar appreciation against the US dollar and Asian currencies, that industry now has to contend with the repercussions of the economic slowdown in the United States, which provides a market for 40 per cent of its production on average. The difficulties should mostly affect the car industry and the plastic and rubber processing segments closely tied to it as well as wood and paper, both highly enmeshed in the North American economy. For that same reason Ontario and Quebec should be the provinces that suffer most.

The economy should grow 1.7 per cent this year against 2.7 per cent in 2007. The marked slowdown is attributable to the increasingly negative foreign trade contribution to economic growth: the expected increase in revenues from raw material sales will be far from enough to offset the decline in manufacturing product shipments to the United States. Imports meanwhile will remain at a high level amid continued strong domestic demand as much from households as from public administrations and companies. Household consumption will remain underpinned not only by a bright job and wage picture in the primary sector and services (70 per cent of GDP), especially public services but also by accommodating monetary and fiscal policy. Service companies (including commerce), benefiting from temporarily more favourable amortisation rules, will increase their investments in commercial and office premises. Public institutions will continue to spend heavily on infrastructure, health, and education. The tightening of credit will, however, undermine residential construction (40 per cent of building and public works activity.

Although corporate financial health is still good overall as reflected by the good level of the Coface payment incident index and the continued decline of bankruptcies, sources of concern have emerged in some sectors and regions. There is a growing economic disparity between the western provinces buoyed by raw materials and the central provinces (Quebec, Ontario) very dependent on a manufacturing industry buffeted by both unfavourable exchange rates and the decline of sales to the United States.

While the aviation industry and capital goods intended for energy production, mine operation, construction, and grain farming have been faring well other manufacturing sectors have experienced difficulties. Car industry parts manufacturers, which do 90 per cent of their business with the Big Three North American carmakers, have been suffering from the decline of local production and the reduced proportion of Canadian parts in vehicles. The wood industry has been contending with the collapse of the construction market in the United States. The paper industry will have to continue restructuring due to the decline in newsprint consumption, the level of competition, and rising costs. In merchant services, two sectors experiencing difficulties — tourism suffering from the decline in visitors from the United States and road transport suffering from the increasing cost of petrol and the reduction of exports — are in sharp contrast with retail commerce, which continues to outperform, except in the segment operating near the US border.


Mexico
A3 rating
Negative watchlist on the A3 rating

Reasons for the negative watchlist status: Several factors underlie the decision to negative watchlist Mexico's A3 rating: Its GDP growth has weakened due to the slowdown in the United States' economy on which Mexico remains dependent for 80 per cent of its sales abroad. The US slowdown should moreover cause a decline in transfers by emigrant workers, particularly those employed in the United States' property construction sector, with those transfers representing about three per cent of GDP. And recent payment experience shows some deterioration developing in a context of weakness in some sectors suffering from a lack of competitiveness.

Growth should weaken in 2008 to just over two per cent due to the slowdown in the United States' economy on which Mexico continues to depend as a market for its exports. Fiscal stimulation measures were thus taken early March this year to bolster domestic demand. That will have a negative impact on public sector finances, which remain dependent on oil revenues. The trade deficit should represent one per cent of GDP due to the sluggishness of exports to the United States, decline of oil production, and slowdown of emigrant worker transfers. Foreign direct investment should, however, cover the country's financing needs while its already moderate foreign debt ratios should improve further. Efforts to modernise the economy, and particularly to reform state-owned companies in the energy sector, have come up against stiff social and political opposition, meanwhile, with President Calderon's conservative PAN party lacking a parliamentary majority. The adoption in 2007 of partial pension and tax reforms initiated by the president nonetheless represent an encouraging step forward.

In this context the business environment still needs improvement and although payment experience has remained relatively satisfactory, it has been deteriorating since late last year. Sectors associated with construction and retail sales have been the most dynamic. The difficulties experienced in some sectors, notably the textile, clothing, and shoe industries reflect their ineffectiveness in meeting foreign competition, particularly from Asia.


Japan
A1 rating
Negative watchlist on the the A1 rating

Reasons for the negative watchlist status: The growth outlook has been revised down to 1.4 per cent due to the slower growth of exports affected by the yen's sharp appreciation and the economic slowdown in the United States and Europe, respectively 25 and 15 per cent of exports sales. Dysfunctions in awarding building permits continue to impede residential investment. The continuing decline of real wages — a labour shortage notwithstanding — has undermined household consumption (56°per°cent of GDP). While the profitability of large companies has remained high, the margins of smaller manufacturing companies continue to shrink, affected by rising energy and raw material prices. Corporate bankruptcies have been increasing, particularly small companies focusing on the domestic market.

Growth forecasts for 2008 have been revised down to 1.4 per cent. The yen appreciation in conjunction with the pronounced economic slowdown in the United States continues to impede export growth. Although continuing to make productivity gains companies have been struggling to stay price-competitive. The increasing cost of energy, certain raw materials, and transport has moreover been putting increasing pressure on their margins, particularly those of smaller companies.

In this context, companies will continue to exercise vigilance in their investment and hiring policies. Despite the scarcity of skilled labour, wages should only rise slightly with employees that go into retirement generally replaced by irregular jobs.

Those practises thus contribute to durably limiting the growth of household consumption, which represents 56 per cent of GDP. Households have been cutting back on spending as they necessarily focus on coping with soaring energy and food product prices, which undermine their purchasing power. With consumer prices only increasing slightly despite the upward pressure exerted by imported goods, the spectre of deflationary risk thus continues to loom over the Japanese economy. The fiscal deficit and the public debt remain at record levels with revenues at a virtual standstill amid the economic slowdown.

Japanese companies in general enjoy good financial health with good return on capital representing about 11 per cent of GDP, large cash flows, and their reliance on credit declining steadily as they reduce their indebtedness albeit with the residual debt nonetheless still high at 95 per cent of GDP. Companies should thus not suffer from a credit crunch even with the economic slowdown and high raw material prices undermining their profit growth (down 4.5 per cent in the 4th quarter last year. These positive factors — benefiting mainly large manufacturing companies — obscure the reality confronting smaller manufacturers. They constitute 99.7 per cent of Japanese manufacturing companies and, according to the Tax Commission, only one in three is profitable. Dependence on a single client has compelled many of them to steadily reduce their margins in recent years and to such an extent that, today, rising energy, transport, and raw material costs put them in jeopardy. The Japanese economic slowdown has particularly affected smaller companies located outside major metropolitan areas and focused exclusively on the domestic market. After declining for four years bankruptcies have thus been trending up again, primarily affecting smaller construction, retail, and service companies.


Western Europe

Economic activity has been slowing in Europe with the euro zone only expected to grow 1.8°per cent in 2008 against 2.6 per cent in 2007 and growth will also be markedly slower in the, United Kingdom, up just 1.9 per cent in 2008. Residential construction and the housing sector in general are no longer contributing to GDP growth and are even making negative contributions in several countries. Although the American slowdown and unfavourable exchange rates have moreover affected exports, continuing strong demand from emerging countries has, however, mitigated the damage. To a lesser extent, sagging confidence, tightening credit, and a less bright job picture will undermine household consumption and corporate investment. The slowdown will be more severe in countries like the United Kingdom, Spain, and Ireland due to the relative weight of residential construction in their economies and the substantial indebtedness of their economic actors. Countries like Sweden, the Netherlands, and Switzerland will fare better.

In this context the profitability of companies associated with housing — builders, developers, agents, manufacturers and distributors of materials, electrical equipment, furniture, and home appliances — should decline. Other sectors like car industry subcontracting, textiles, leather, paper/cardboard processing, and IT equipment assembly will remain weak. The payment behaviour of smaller, relatively indebted companies in those sectors could be subject to deterioration.


Germany
A1 rating

In 2008, after two years of buoyant activity, growth should only post a 1.7 % increase, consistent with the long term economy's potential. A smaller positive contribution from foreign trade will not be offset by the recovery of private consumption. The growth of exports will be slower due to the economic slowdowns in Europe and the United States. Import growth will remain strong meanwhile reflecting the timid recovery of household demand, supported by the continuing decline of unemployment and the concomitant decline in the unemployment-insurance contribution rate as well as by the extension of compensation for elderly. The revival of private consumption will nonetheless be modest due to the unfavourable effect of the rising cost of energy and food. The progression in disposable revenue -despite significant salary increases observed in certain sectors following social movements- will remain feeble. Faced with weaker foreign demand, industry will slow the pace of its investments.

Corporate payment behaviour remains good as evidenced by the excellent level of the Coface payment incident index for Germany and the 3 per cent decline in bankruptcies in 2007 (despite an increase in the 4th quarter). The reduction of corporate income tax this year in a context of balanced public finances will have a positive influence on that trend. The residential construction sector will remain mired in difficulty, however, particularly in the eastern regions. And the kitchen furniture sector also presents a high risk profile at this juncture. The automotive sub-contracting sector, meanwhile, has suffered from the increasing pace of relocations to the eastern part of the continent.

France
A1 rating

Economic growth should ease to 1.7 per cent in 2008 after 1.9 per cent in 2007. Households, with their confidence sagging further in February according to the French national statistics agency INSEE, will be likely to continue to exercise prudence on discretionary spending and to replenish emergency savings (over 16 per cent of disposable income). After slowing in the first quarter, household consumption (57 per cent of GDP) should maintain a satisfactory level in subsequent months. Government measures including a fiscal package, overtime pay, work time reduction, and decontrolling of profit sharing should bolster their purchasing power and partly offset the impact of rising energy and food prices.
Lending to households, particularly in relation to housing, continued its gradual decline since end 2006. The tightening of conditions for the granting of bank loans will continue to affect residential investment with building permits down a cumulative 5.3 per cent for the year ending January 2008. The construction of office premises has levelled off, which could augur a corporate investment slowdown, under the effect of higher loan rates and the greater difficulties encountered in arranging financing for infrastructure. The steady erosion of corporate profits as a percentage of GDP, down from 8.5 per cent in 2000 to 5.2 per cent in 2007, and of cash flow ratios (down from 85 per cent in 2000 to 60 per cent in 2008) has made companies particularly sensitive to the cost of the credit on which they rely more heavily since 2004. The domestic demand slowdown will tend to undermine import growth, which should contribute to a slight reduction in the current account deficit. Less dynamic demand from European trading partners in conjunction with the euro appreciation will, however, keep exports from growing enough to take full advantage of the import slowdown.
Corporate bankruptcies have begun to increase again (up 5.4 per cent in the first three quarters of 2007). That trend reflects the ongoing deterioration of corporate margin rates especially for smaller companies unable to pass on price increases for intermediate goods in their ultimate sales prices and faced with stiffer conditions for the granting of credit. Industrial sectors with high debt — particularly car industry and aviation subcontracting, paper, and metallurgy — will bear watching. Vigilance is also in order as regards the IT assembly and distribution sectors, swine industry (breeders, cooperatives, slaughter houses, distributors), and cattle-feed and fertiliser wholesalers and cooperatives. In construction, the bottoming out of orders from promoters could affect certain subcontracting companies.


Spain
A1 rating negative watchlisted since October 2007

In 2008, the Spanish economy should make a soft landing (+2.3 % growth) attributable to the decline of residential construction and a further slowdown of private consumption. The trend will nonetheless remain consistent with the economy's potential. Consumption will suffer from the upsurge of inflation spurred by the increasing cost of energy and food. Growing unemployment, the result of both a more sluggish job market and the growth of the working population will also be a negative factor. Other factors will, however, cushion the effects of the downturn, particularly the financial support extended by the government in the form of rental subsidies for youth and low-income families, increases in low pensions, and income tax reductions made possible by good public-sector financial health. Although corporate investment in facilities and buildings will slow, that will be partly offset by continued public spending on infrastructure under a multi-year modernisation programme (PEIT). The considerable development of research and development programmes intended to remedy the lack of competitiveness will also serve as a shock absorber. Exports will continue to develop at a rate close to that of world trade and remain relatively unaffected by the American slowdown.

Payment behaviour that has been satisfactory until now — notwithstanding a few accidents in textiles, small electric equipment, or computer assembly — could deteriorate. Already in 2007, the bankruptcy trend turned slightly up in the third quarter, and then, toward year end, the Coface payment incident index showed some deterioration. The smaller, often debt-burdened companies associated with the housing market (light work, real estate agencies, promoters, manufacturers and distributors of material and furnishings for the home) that have proliferated in recent years would then be the most exposed. Road transport could, however, suffer from rising petrol prices while the car industry will have to contend increasingly with competition from Eastern Europe and the sluggishness of domestic vehicle sales.

United Kingdom (A1)
A1 rating negative watchlisted since June 2007

In 2008, the British the economy will be markedly less dynamic than 10 2007 (+1.9%) due mainly to sharp slowdown of both household consumption and investment. Households will be faced with a slower pace of job creation, which will not, however, result in increased unemployment with immigration easing. The slow growth of their disposable income, attributable to persistent inflationary pressures and substantial wage moderation, will be more difficult to offset through borrowing. Despite a reduction in the Bank of England's key rate, credit will become both more expensive and less available with financial institutions, aware of the sharp increase in personal bankruptcies in 2007, exercising greater caution. In this context, residential construction could well decline. Office construction will slow due to the slowdown in services. Ongoing preparations for the 2012 Olympic Games along with the continuing dynamism of school, hospital, and road and rail infrastructure construction will only partly offset that trend. Only the performance of goods exports, despite the flagging dynamism of the US market and the decline of the dollar, should improve thanks to the weakening of the pound sterling against the euro. That will not suffice, however, to reduce a very large trade deficit only partly offset by the recurrent surplus position of the services and investment income balance.

In 2007, the Coface payment incident index remained satisfactory bearing out the decline in bankruptcies. Corporate profitability remained high with profits increasing 10 per cent. They could level off in 2008, albeit at a good level, amid a decline in economic activity. Although that will have little effect on large companies in view of their low-debt positions and good cash flow, smaller companies with limited access to the financial market and that rely on adjustable-rate loans in consequence will experience difficulties to varying degrees. The housing and home furnishings (manufacturing and marketing sector) should suffer from the decline in residential investment, even if that can be partly offset by orders from the public sector orders or related to preparations for the Olympics. In a context of sluggish consumption, competition between mass distributors will exacerbate.

Italy
A2 rating

In 2008, growth should slow (+0.9%). Despite tax breaks (tax credits for taxpayers with no tax liability and youth entering the rental market, and reduction of the local share of property tax) made possible by the improvement in public finances and the campaign against tax fraud, household consumption will slow amid a weakening job market and rising grain prices. Although the automotive industry will continue to perform well in Europe, other export sectors will suffer from the unfavourable exchange rates and the deterioration of economic conditions in the United°States and Europe. Public sector investment will lack buoyancy while residential construction will decline slightly under the effect of the credit crunch. Corporate capital equipment purchases will increase further due to the high capacity utilisation rates resulting from the lack of investment in recent years.

Despite sharp improvement since 2005, the Coface payment incident index remains well above the European average. Initiating collection procedures is still a slow process. Even if the income tax rate applicable to profits eases from 33 to 27.5 per cent, payment behaviour will deteriorate, in view of the less buoyant international environment and higher input costs. This deterioration will nonetheless be limited and localised. The margins of companies trading with the dollar zone will suffer from the unfavourable exchange rates. Construction material manufacturers (ceramic, stone, tile) will moreover feel the effects of the construction downturn in the United States. Milling (flour, pasta) and biscuit making will have to contend with the increasing cost of agricultural raw materials. Home furnishings, like furniture and appliances, should continue to perform well in Europe, benefiting from dynamic renovation activity and the time lag between construction and this type of purchase



Emerging Europe

Regional growth should weaken slightly in 2008, shedding about 0.8 points of growth overall. Although dropping slightly below 5.0 per cent in 2008 (Central Europe + Turkey), the growth rate will nonetheless remain nearly three points higher than that of the EU of 15, the region's main trading partner. Good domestic-demand performance and growth of Central Europe's market share in Western European imports will limit the impact of the foreign demand slowdown. Inflationary pressures will intensify, however, under the effect of higher foodstuff and energy prices, buoyant domestic demand, and the European price and tax harmonisation process. The Polish and Slovakian economies will remain the least subject to inflationary pressures in the region. The resurgence of inflation and the still large public sector deficits in some new member countries, notably Hungary, will jeopardise their chances of rapidly adopting the euro. Many countries are moreover marked by excessive external account imbalances, rapid growth of private indebtedness, and sharp increases in loans denominated in foreign currencies, which make them vulnerable to a currency crisis or sharp growth adjustment. The weakest countries on that score include the Baltic States, Romania, Bulgaria, along with Hungary and Turkey with the latter two countries currently in a stabilisation phase, however, after the economic slowdowns that developed in 2007 following implementation of restrictive policies. In a context of increased volatility in financial markets linked to the subprime crisis, risk premiums for most of these countries increased more sharply than they did for other regional countries. Regional currencies have, however, generally recovered since summer 2007 with the notable exception of the Romanian leu. Our privileged scenario at this juncture is still based on a soft landing for the weaker regional economies.


Emerging Asia

Economic growth should be down point this year, easing from 8.7 per cent in 2007 to 7.7 per cent in 2008, affected by the American and European slowdowns in the wake of the subprime crisis and by the pursuit of anti-inflation policies. Emerging Asia will thus remain relatively resilient underpinned by the increasingly large role played by domestic demand in the growth dynamic and the financial health of most regional countries. The good regional performance gets a major boost moreover from the booming Chinese and Indian economies, which represent a combined 55 per cent of emerging Asian GDP. The countries with the region's most open economies should, however, suffer most and could lose as much as two or three points of growth as a result of the slowdown of their exports. Taiwan will also remain weak and negative watchlisted due to its dependence on economic conditions in the United States, which constitutes the ultimate re-export destination of about 70 per cent of Taiwanese exports to mainland China and thus constitutes the island's main trading partner: the Coface payment experience on Taiwanese companies has deteriorated with their margins shrinking for the third straight year.

China's economic development, meanwhile, is pregnant with risk as evidenced by disturbing signs of overcapacity — especially in steel, the car industry, retailing, and property — and overheating. After reaching 6.5 per cent in 2007, inflation accelerated again in January and February this year, up respectively to 7.1 and 8.7 per cent. Concerned about the potential social repercussions, government officials have reaffirmed the priority given to combating inflation in 2008. Officials should thus give greater emphasis to monetary tightening, speedier appreciation of the yuan, and various administrative-type measures, like price freezes. Besides their expected impact on inflation, those measures should also make it possible to exercise greater control over growth and pave the way for a soft landing.

On the financial level, there continues to be little risk of external overindebtedness as evidenced by the improvement in regional debt ratios. As a result of large current account surpluses, however, stock, property, and credit markets are awash with liquidity. After rising strongly in 2006 and 2007, Asian stock market indices have been declining sharply so far this year, reaching levels comparable to those registered in summer 2007. Despite the sharp declines, price earnings ratios have remained high, attesting to the continued existence of speculative bubbles. PERs are thus still high in China, still above 60 on average in the A-share market. Price earnings ratios are also high in India (20) and Indonesia (21). In this context of overvalued stock markets, the increased volatility observed in January and February 2008 and should continue throughout the year. But the heightened volatility will only have a limited impact on the Chinese economy with domestic savings mainly responsible for driving the indices up. In Indonesia, and to a lesser extent India, however, the risks appear to be greater with the bursting of a stock market bubble likely be accompanied by capital flight with major repercussions on the country's exchange rates and thus on inflation and economic growth.


Latin America

Growth should slow in Latin America this year — 4.3 per cent in 2008 down from 5.3 in 2007 — amid a less buoyant international environment and the economic slowdown in the United States, even with domestic demand still making a decisive contribution. Continued strong world demand, notably in Asia, for staple commodities should, however, allow the region to continue to consolidate external accounts and build up foreign exchange reserves. The foreign debt reduction process is thus solidly on track while the pursuit of suitable monetary and fiscal policies in conjunction with the steadiness of local currencies should facilitate efforts to keep the upsurge of inflationary pressures under control — except in Argentina and Venezuela — and foster continuing efforts to overhaul public sector finances. The large regional economies will thus be unlikely to experience any major difficulties with financing, tighter credit conditions at the world level notwithstanding, Although the political situation in some countries — Venezuela, Bolivia, Ecuador — remains marked by radical tendencies, most regional countries have adopted moderate stances. The institutional and business environments nonetheless leave ample room for improvement. Corporate payment behaviour has remained satisfactory in this context even with some sectors like textiles still contending with competitiveness problems and others like agriculture remaining vulnerable to weather conditions.


North Africa and Near & Middle East

The inexorable rise of crude prices — up 77 per cent on a 12-month moving average basis and up over 10 per cent so far this year with the price per barrel of North Sea Brent reaching $109 this 13 March — has, to put it mildly, benefited regional oil producing countries. The ongoing windfall will sustain large infrastructure projects, whether in the Gulf monarchies or Algeria. Public and private investment along with household consumption, underpinned by the improvement in incomes and a growing expatriate population, should continue to support economic dynamism. The outlook thus remains very bright for these economies whose growth rates should remain high (five per cent) despite a flatter crude oil production trend as a result of the expected slowdown of Western demand. The property sector has been the main vector of regional growth particularly in Dubai where it nonetheless continues to bear watching. The economic boom can, however, generate choke points affecting both prices and delivery times. Foreign debt has been growing, except in Algeria, which has been pursuing restrictive policy on that score. The risk of overindebtedness is in any case offset by the ongoing accumulation of extensive holdings abroad. Rising prices for rent and, despite subsidies, for petrol and food products, have generated inflationary pressures exacerbated by the depreciation of the dollar to which the currencies of most Gulf monarchies are pegged. With their dollar-denominated assets, however, any revaluation of their currencies would be a two-edged sword. The outlook for Iran, meanwhile, is subject to greater uncertainty. Its intransigence on the nuclear issue prompted the United Nations to impose a third round of sanctions (Resolution 1803) adopted by the Security Council early March. The new measures are still not very limiting, but the financial embargo imposed by the United States should, however, continue to affect corporate payment behaviour and thus increase transaction costs.

Petrodollars from the Gulf monarchies have indirectly benefited the other regional countries through investments, tourism, and emigrant worker remittances. The economic slowdown in the United States and Europe could, however, have a negative impact on regional growth especially in Israel and Jordan. The cost of oil will be particularly prejudicial to Lebanon and Jordan, which have high external deficits. Whatever objectives a government may adopt, however, consolidating public sector finances by reducing subsidies will certainly be difficult to achieve whether in Egypt, Jordan, Lebanon, or Yemen. With their low-income populations those countries will probably try to avoid the social upheavals that unfailingly play into the hands of Islamist movements. They could thus continue to run high public sector deficits generally part-financed by grants-in-aid.

Geopolitical tensions continue to run high in this part of the world, spurring Islamist movements in opposition to the governments in power, which generally maintain good relations with the United States. Prospects for resumption of a peace process in the Middle East appear very uncertain considering the ongoing tensions in the Palestinian Territories. The still-chaotic situation in Iraq continues to have a destabilising influence on the region. The Iranian nuclear issue remains a major element of uncertainty fostering increased diplomatic activity. The outcome of the legislative elections of 14 March, which strengthened moderate conservatives, will apparently change nothing on that score. An upsurge of terrorist activity targeting North African countries, meanwhile, will bear watching.



Sub-Saharan Africa


Economic growth reached 6.5 per cent in sub-Saharan Africa in 2007 and should climb to 6.8°per°cent in 2008. That dynamism has been mainly underpinned by the firmness of oil prices, which have been trending up again this year particularly to the benefit of oil exporting countries like Angola and Equatorial Guinea in a position to expand production capacity. The continent in general has benefited from firm raw material prices buoyed by demand from China and India. Soaring ore and metal prices have not only contributed to improving the terms of trade but have also spurred foreign direct investment inflows. In this context the slight slowdown of American demand following the subprime crisis will thus have no significant impact.

Firm raw material prices and the debt relief granted to highly indebted poor countries under the HIPC and MDRI programmes have resulted in significant improvement in financial ratios. The external positions of sub-Saharan African countries have nonetheless been mixed. Most of the countries are net importers of oil and foodstuffs, whose prices have been rising. Infrastructure development moreover entails increased capital equipment imports. In this context debt will inevitably increase further.

And the continent's development is not necessarily sustainable. Especially with the persistence of many structural weaknesses: A productive fabric lacking diversification makes the continent vulnerable to a downturn in raw material prices. The relative size of the farm sector results in vulnerability to weather conditions. Deficient transport and energy infrastructure impede gains in productivity. The high poverty rate shackles human capital. A difficult business environment deters foreign direct investment inflows. And political risk remains high with a multitude of domestic or sub-regional uncertainties (Côte d'Ivoire) capable of jeopardising the outlook.




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