Is CEE Better Prepared This Time Around?

The EU summit this past week did nothing to address the underlying causes of the eurozone debt crisis, which leaves the global economy looking increasingly wobbly. Central and Eastern Europe (CEE) has particularly close ties to the eurozone and suffered a disproportionately sharp economic downturn in 2008-09. So how will the CEE region fare this time around?

Erste Bank argues in a new CEE Special report that the region is now better prepared to weather global turbulence. However, I see some major flaws in their argument.

Most egregiously, the author – Juraj Kotian – uses the eurozone as a basis for comparison, rather than other EMs, thereby painting a rosier picture of the region than is warranted. As the eurozone is in the midst of a battle for its very survival, it should be no surprise that the CEE economies appear resilient by comparison.

So why does Erste believe this time is different?

1) CEE countries are far less indebted than the governments or the private sector in the eurozone.

2) High current account deficits in the region have narrowed, and many CEE countries now hold bigger caches of international reserves.

3) CEE economies are in a different stage of the economic cycle. In 2008-09, these economies were running above potential (i.e. overheating). Now these economies are running close to potential or slightly below.

As a result, Kotian concludes that CEE economies “should do much better (relative to the Euro Area) than in the post-Lehman recession.”

There’s more to the story

Erste Bank is not a disinterested observer. As FT’s Beyond Brics notes, the bank has extensive operations across the CEE, providing it with an incentive to accentuate the positive. The author Juraj Kotian’s arguments can not be dismissed entirely, but there’s more to the story.

1) Yes, CEE economies are far less indebted than advanced economies, as Kotian notes, but…

…they have higher external debt burdens than other emerging markets, as seen in Figure 1.  In fact, external debt has increased, as a % of GDP, across all the five CEE countries surveyed since 2007.

Figure 1: External debt burdens remain higher than in other EMs

Source: National central banks, IMF, Emerging Market Musings

As for public debt, levels in the region are largely in line with those in other EMs, but CEE countries have added debt at a much faster pace. Levels are now significantly higher than before the onset of the global financial crisis, as seen in Figure 2 (Bulgaria is an exception). This negative trend is due, in large part, to the region’s sharp GDP contraction in 2008-09.

Figure 2: Public debt levels have risen sharply in most CEE countries since 2007

Source: IMF

2) Current account deficits have narrowed across the region, while international reserves have increased. But…

…the stock of external debt has also risen. This means that reserves coverage of the external debt has not changed significantly compared to pre-crisis levels. As seen in Figure 3, Hungary’s ratio has increased, but those in Bulgaria, Czech Republic and Romania have declined.

Figure 3: Despite increases in international reserves, the reserves coverage of external debt has fallen in several countries

Source: Emerging Market Musings, national central banks, IMF

Kotian has a point when he notes that current account positions across the region have improved. In fact, surpluses have replaced deficits in Bulgaria and Hungary. However, one of the main driving factors behind this improvement is weak domestic consumption (with the exception of Poland), which has limited import growth. In both Bulgaria and Hungary, consumption contracted on an annual basis in 2010. So, while the current account improvement is generally positive, it’s due in part to underlying economic weakness, which is not positive.

International reserves positions and current account deficits are important early warning indicators of a country’s susceptibility to a sudden stop in capital flows. (See my recent post: Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators)

3) What about banking system health?

Kotian lists three reasons why the CEE should prove more resilient this time around. However, he overlooks an important weak spot – the banking system. Another credit squeeze is a very real possibility.

Non-performing loans remain elevated. Meanwhile, the persistence of high loan-to-deposit ratios leaves CEE banks reliant on external funding (see Figure 4), either from foreign parent banks in Western Europe or from wholesale markets.

Figure 4: High loan-to-deposit ratios signal CEE banks’ reliance on external funding to finance lending

Source: Fitch Ratings

Western European banks dominate the CEE market via subsidiaries. If the euro area debt crisis intensifies, these banks are unlikely to pull out of the region, but they will still likely scale back support for their subsidiaries. As the IMF notes in its latest Regional Economic Outlook for Europe:

“The most likely impact would therefore be a renewed credit crunch. Subsidiaries would see a measured but persistent funding drain from their parents, and nonaffiliated banks that rely on wholesale funding would have to struggle even more. Both would have little choice but to curtail their own lending activities.”

Signs of a credit squeeze are already apparent. According to the IIF’s latest Emerging Markets Bank Lending Conditions Survey, 81% of emerging European banks reported a tightening of external funding conditions in Q3 2011. This tightening will exert a major drag on economic growth across the region.

The Weekly Mishmash: October 24

1. Internationalization of Emerging Market Currencies–A Balance between Risks and Rewards

By Samar Maziad, Pascal Farahmand, Shengzu Wang, Stephanie Segal, and Faisal Ahmed, IMF

This paper points to signs that a ‘slow but steady increase’ in the use of emerging market currencies in international transactions is underway. Nevertheless, the US dollar and euro continue to overwhelmingly dominate.

“Key EM currencies with potential for internationalization are the Brazilian real, Chinese renminbi, Indian rupee, Russian ruble, and South African rand. All these economies have significant regional importance and economic weight.” They conclude that, going forward, “it seems likely—if not inevitable—that emerging market currencies will account for a larger share of international reserves.”

EM Muser: Greater international use of EM currencies is a very slow-moving trend. But we’re living in an increasingly multipolar world, and movement toward a multi-currency system reflects this. Notably, not all EM currencies exhibit the economic size and financial depth to achieve internationalisation, but as noted above, a fair number do. (See my related posts: Forex Reserve Diversification: Is Mauritius a Trendsetter? and EM Currencies: Same Same But Different)

2. Hungary mulls porn tax to fund film biz

By John Nadler

The Hungarian government’s latest creative financing proposal,  put forward by MP Laszlo Simon, involves slapping a new tax on the porn industry to subsidize locally produced films.

EM Muser: Creative is one adjective I would use to describe Hungary’s government, although I can think of a number of less pleasant adjectives as well. In truth, a porn tax is probably not be a bad idea…nothing like a good vice tax to raise some revenue without losing popular support. However, I find parliament’s interest in this trivial issue at a time when government finances are rapidly deteriorating to be disturbing.

Hungary is walking a tightrope as its debt rating teeters on the verge of ‘junk’ status – a one-notch downgrade from any of the three major ratings agencies would do it. Yet, MPs seem to think now’s the time to advance their pet causes rather than implement real reform. Not a good sign. (See my related posts: Hungary’s Vicious Circle: Anemic Lending and Weak Growth and Hungary’s Latest Debt Relief Plan: From Bad to Worse)

3. Strong Domestic Demand Cushions Indonesia from Global Uncertainty

By the IMF Survey Magazine

The IMF sees relatively clear skies ahead for Indonesia, making it a bright spot in an increasingly gloomy global outlook.

“The outlook is very robust. In the near term we expect Indonesia to continue to grow above 6 percent both in 2011 and in 2012. We say this despite the global volatility we see because the domestic foundation of economic growth in Indonesia is so strong. We see strong credit growth, and despite lower growth in the rest of the world, we think that Indonesia is still going to grow at a strong rate.”

EM Muser: The consensus is that Indonesia is likely to show considerable resilience in the face of global market turmoil. This coincides with my own findings  (See related post: Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators) and with what analysts Devi Tan and Seen Meng Chew at Morgan Stanley have also concluded. 

4. A Flat World Will Take a Long Time to Smooth Itself Out

By Pankaj Ghemawat, Bloomberg

Ghemawat notes that most people overrate the degree of cross border integration and he throws out some great statistics to illustrate his point and provide food for thought.

Did you know that only 3% of the world’s people actually live outside the country in which they were born, and only 2% of university students study outside their homelands? Or that only 2% of telephone calls are international, and less than 18% of Internet traffic crosses national borders? He also points out that FDI makes up a paltry 9% of all fixed investment globally.

EM Muser: There has been a lot of focus on the process of globalisation over the past few years, and a general assumption that the pace is fast and furious. I love this piece because Ghemawat provides a reality check and argues that we’re still really not all that integrated. It reminds me that it’s always a good idea to question and evaluate our assumptions.

Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators

All eyes are now on the eurozone debt crisis. However, we know from past experience that problems in advanced economies can spill over to the rest of the world with dangerous consequences. Emerging markets are not immune. The IMF Director Paulo Nogueira Batista Jr recently expressed concern that capital could flee Brazil if the eurozone debt crisis intensifies, and his concern is not unfounded.

As seen in 2008-09, global risk appetite dried up and prompted large capital outflows out of many emerging markets, particularly in Eastern Europe. As a result, certain economies found themselves teetering on the edge of crisis. Latvia, Hungary and Romania were among those who turned to the IMF for help.

These Eastern European economies showed vulnerabilities before the onset of the global financial crisis, as exhibited by high current account deficits and heavy external debt service obligations. However, it took an external shock to bring these vulnerabilities into the spotlight.

So which EM economies look vulnerable in the event of another sudden stop in capital flows?

Below I look at a cross-section of emerging markets and compare their relative vulnerability to a sharp slowdown in capital inflows. (Note: the set of EMs was chosen largely based on data availability).

There is no defined set of early warning indicators that perfectly predicts which countries are at risk of a crisis, but some have stronger predictive power than others. Jeffrey Frankel and George Saravelos conducted a sweeping literature review to find the most consistent leading indicators of crisis. (See: Reserves and other early warning indicators work in crisis after all)

Measures of international reserves and the real exchange rate stand out as the best tools to assess a country’s vulnerability. Their findings suggest the current account balance is also a good indicator to monitor.

Figure 1: Adequacy of international reserves

Source: IMF, national central banks, author’s calculations

*Stock of external debt as of June 2011, **GDP based on IMF’s latest 2011 forecast

International reserves provide a certain degree of insurance against capital flow volatility. Among the EMs surveyed, Russia and India stand out for their relatively large caches of international reserves, while Turkey ranks near the bottom of the pack, both as a % of external debt and % of GDP, which is a source of vulnerability. Blogger Emre Deliveli, as well as journalist Taylan Bilgic, questioned the adequacy of Turkey’s reserves in a recent column.

The ratio of short-term debt to reserves is a particularly good measure for assessing vulnerability. The lower the ratio, the better. Unfortunately, not all countries provide data on short-term debt, but a few do. For example, India’s ratio is 21%, well below Turkey’s ratio of roughly 86%.

This measure, like the others, needs to be taken with a grain of salt. A country may have a large chunk of debt coming due within the next year, but may have very strong macro fundamentals, making repayment problems highly unlikely. So it’s always necessary to consider the context. In any case, Turkey also looks vulnerable on this measure.

Figure 2: Divergence of Real Effective Exchange Rate from Trend

Source: BIS, author’s calculations

The probability of a currency crisis increases when the real exchange rate is overvalued relative to trend. However, this needs to be taken with a grain of salt as well. For example, many Asian currencies showed no significant appreciation in the late 1990s, yet these economies still descended into crisis.

On this measure, the Brazilian real and Indonesian rupiah currently show the most overvaluation relative to trend. In contrast, Turkey looks to be the least vulnerable on this measure.

Figure 3: Current account balance

Source: IMF WEO Database, September 2011

Large current account deficits also increase the probability of crisis and indicate that a country is borrowing more than it’s saving. All recent financial crises (eg. the Asian Crisis, Argentina in 2000, Brazil in 2002) featured current account deficits, with the exception of Russia in 1997. A current account deficit is not necessarily a bad thing if it is financing activities that are enhancing the country’s productive capacity. However, a deficit can quickly become unsustainable if a country is unable to secure the necessary external financing to fund it.

On this measure, Turkey – and to a lesser degree, Poland – look potentially vulnerable.

Conclusion

A look at early warning indicators suggests that Turkey is vulnerable to a sudden stop in capital flows based on its relatively low level of reserves and high current account deficit. Poland also looks vulnerable – albeit less so than Turkey. However, as I note above, these measures need to be taken with a hefty grain of salt. They’re useful in figuring out where a countries’ vulnerabilities may lie, but further investigation is necessary to understand the context.

The Weekly Mishmash: October 16

1. Brazil’s states in ‘tax war’ to win iPad production

By Joe Leahy, FT

The state of Manaus, in the Amazon basin, is facing stiff competition from other Brazilian states for a massive technology project to produce iPads.

“[T]oday Manaus is fighting for its life. The city is vying to secure one of the biggest technology projects Brazil has ever seen – a $12bn plan to produce iPads. But more powerful states, particularly São Paulo, Brazil’s wealthiest and most industrialised, are trying to win the project by offering tax breaks of their own – benefits that Manaus claims are illegal under the constitution and could fatally erode the tax advantages of manufacturing in the Amazon.”

EM Muser: Tax wars are not isolated to state governments. This is also a trend seen at the global level as national governments compete against each other, offering huge tax breaks in a bid to win foreign investment. I believe that this is one of the reasons, among many, behind the public debt crises we’re now witnessing in advanced economies.

Large companies are often able to pit governments against each other in a bid to sweeten their tax breaks. This results in a ‘race to the bottom’ that favours multinational companies at the expense of states, which suffer from reduced fiscal revenue. The only real way to end such bidding wars is through some kind of cross-country tax harmonisation, which looks unlikely anytime soon.

2. Indonesia: Pre-emptive Rate Cut In Anticipation Of Global Downturn

By Ho Woei Chen, United Overseas Bank

Indonesia’s central bank surprised markets by cutting its benchmark interest rate by 25bp, bringing it back to 6.5%, the record low reached during the global financial crisis. UOB’s Chen sees the central bank move as risky.

“We see the interest rate cut slightly premature at this point given that domestic growth has remained resilient…The rate cut which was targeted at supporting growth could increase capital outflow risk in the environment of global uncertainties. We have seen foreigners paring their holdings of the Indonesian government bonds down to 31.3% of total outstanding in September from 35.1% in August.”

EM Muser: Indonesia has joined Brazil and Turkey, the first major EMs to cut rates preemptively amid increasing signs of a major global slowdown. Brazil and Turkey’s decisions came under heavy criticism, as has Indonesia’s. However, the latest Emerging Markets Purchasing Managers’ Index, compiled by Markit/HSBC and released on Oct 12th, provides yet another confirmation that a slowdown is underway.”Emerging market manufacturing output fell in Q3, bringing to a close nine successive quarters of growth.”

I believe these central banks are ahead of the curve and are doing the right thing. (See my post: Giving Turkey’s Central Bank the Benefit of the Doubt.) But, as Ho Woei Chen notes, this strategy is not without risks. Those EMs, like Turkey, which are running large current account deficits and are heavily dependent on foreign capital inflows to fund it, have to hope their strategy does not trigger major capital outflows. Other EMs, like Brazil and Indonesia, that have strong reserve positions and lower levels of external debt are in a better position to weather an episode of capital outflows.

3. Here’s What the Wall Street Protesters are So Angry About

By Henry Blodget, BusinessInsider

Blodget, a former top-ranked Wall Street analyst, looks at what’s behind the Occupy Wall Street protests and provides some excellent graphs to illustrate his points. His conclusion is that they have legitimate gripes: “Inequality in this country has hit a level that has been seen only once in the nation’s history, and unemployment has reached a level that has been seen only once since the Great Depression. And, at the same time, corporate profits are at a record high.”

EM Muser: As I discussed in a post a while back, a growing economy – an expanding pie – is generally a very good thing, but there are different kinds of growth – some much more healthy and sustainable than others. There’s ‘jobless growth’, debt-fueled growth, as well as growth accompanied by higher levels of inequality and these are not mutually exclusive. (See my related post: Unhealthy Obsession with GDP.) Income inequality in the US is now worse than in Iran, India, or Russia, while corporate profits are near an all-time high. This situation seems like it can’t be sustained indefinitely, and the Occupy Wall Streets are a reminder.

4. Capital controls

By Lex, FT

This column concedes that perhaps capital controls are not as bad as they have been made out to be. The flight of speculative investment is blamed for the sell-off in emerging Asian assets in August and September, and the column notes that if these investors had longer-term horizons, they wouldn’t have pulled out. The conclusion is: “For authorities in Taiwan, India, Indonesia and Thailand, all of which have toyed with measures to keep out undesirables, the big Asian sell-off should also be instructive. A new, stronger consensus could emerge: that capital controls are a legitimate tax on those least willing, but most able, to pay it.”

EM Muser: Capital controls have gotten an undeserved bad rap. I am glad to see that the long-held view that any and all capital controls are bad is starting to change. Even the IMF now supports capital controls in certain circumstances. (See my related post: Brazil’s Capital Controls: How Successful?)

Brazil: Time to Make Tax Reform a Priority

Brazil’s business climate has come a long way over the past decade and now boasts macroeconomic stability and a predictable policy environment. However, businesses continue to gripe about the labyrinthine tax system and rightly so. Companies are forced to employ an army of bookkeepers and accountants just to ensure compliance. What is shocking is how well Brazil’s economy is performing given the lack of tax reform, which in turn highlights the potential for higher growth if comprehensive reform is ever implemented.

The tax burden is an issue, but not the main one. Brazil’s overall burden in 2010 was 33.5% of GDP, higher than that in the other BRICs but lower than the OECD average. The more fundamental problem is the tax system’s complexity. I was shocked to see the time that companies in Brazil spend on tax compliance – more than double the time spent in Bolivia and Vietnam, which have some of the most complex tax regimes in the world.

Figure 1: Brazil ranks worst in the world in terms of time spent on tax compliance

Source: Doing Business 2011, World Bank

It’s no surprise that tax regulations are cited as one of the biggest obstacles to doing business in the country, according to the World Economic Forum’s latest Global Competitiveness Report.

A recent article in the Globo newspaper says that, on average, five new tax rules come into effect per hour, making it very expensive for a company to keep up.  A survey by the Federation of Industries of the State of Sao Paulo (Fiesp) shows that companies are spending a total of R$19.7bn per year, mostly on administrative and personnel costs, to achieve tax compliance, and at least some of this cost is being transferred on to consumers. Locals call it the ‘Custo Brasil’ – a generic term used to describe the outlays associated with navigating the country’s many bureaucratic obstacles.

Why is Brazil’s tax system so complex and why haven’t politicians acted to simplify it?

The fact that there are three levels of tax authorities – federal, state and municipal –  all issuing different sets of rules is a key contributor to the system’s complexity, which leads to the next question. Why haven’t politicians acted when tax reform appears to be a win-win for almost everyone?

Carlos Pereira of the Brookings Institution argues that politicians have opted to keep the current system because it has proven capable of generating high levels of revenue, rather than wasting their political capital to implement a more efficient, yet unproven system. (See: Tax Policy in Brazil: The Issue that Never Was)

“Tax reform initiatives—such as uniformed state VAT legislation all over the country and converting turnover and cascading taxes (PIS/PASEP, COFINS) into a single federal tax—were therefore discontinued by policymakers because of the perceived risks of a fall in revenue due to fiscal uncertainty; and also due to the political costs involved, leading the government to choose a line of least effort.”

Future prospects

Brazil has taken a tentative step toward tax reform with SPED – the Public Digital Bookkeeping System – which is in the process of being implemented. SPED “forces a large number of companies to convert their tax and accounting bookkeeping to a specific and standardised digital format,” as a World Finance article explains. The intended benefits are simpler tax filing, reduced paperwork and improved integration of the different levels of tax authorities. But there are also challenges.

Even with SPED, companies will still need to navigate a complex maze of tax rules. Moreover, in order to minimise the risk of errors in the electronic information provided, they will need new tools and processes to ensure compliance. So, at least in the short-run, the benefits will be offset by increased costs.

Brazil’s new president Dilma Rousseff has acknowledged the need for further tax reform, including in a speech to Congress in February 2011, saying it was essential to ensure sustainable growth. However, her actions have not matched her words. More recently, she has said the government will pursue tax reform in a piecemeal manner. So it looks like a real improvement will be slow in coming.

The Weekly Mishmash: October 9

1.  Why China won’t conquer the world

By Xué Xinran, Telegraph

Ms. Xinran provides a personal account of the growth challenges facing China. She’s a Chinese expat who describes the frenetic pace of life in her homeland and goes on to criticize the education system, saying it ‘stifles rather than encourages creativity,’ an important ingredient for entrepreneurship. She agrees with Larry Hsien Ping Lang, a finance professor at the University of Hong Kong, who fears that China’s ‘bubble economy’ is on the verge of bursting. They believe China’s economy must slow down to give time for its education system and society to catch up.

EM Muser: This article adds to recent commentary (see Patrick Chovanec and Jim Walker) that chips away at the image of China as an unassailable economic giant. While it’s unclear to me how much China will slow and the exact timing, growth forecasts showing Chinese growth continuing at over 9% on an annual basis in coming years look way too optimistic. (See my recent post: IMF’s Latest Growth Forecasts for China Look Overly Rosy)

2. Megatrends for Investors

By Dr. Shane Oliver, AMP Capital

Dr. Oliver  points to strong commodity prices as a key long-term investment trend. “After a 25-year bear market into the end of the last century, commodities are now just over a decade into a secular bull market driven by strong structural demand on the back of industrialisation in China and other emerging countries, all at a time of still- constrained supply. notwithstanding cyclical fluctuations, the longer-term trend in commodity prices is likely to remain strong, possibly accentuated by a continuing long-term downswing in the US dollar and other major advanced country currencies.”

EM Muser: I share a similar view to Dr. Oliver. A growing world population, combined with greater challenges in producing commodities (due to scarcity or climate change in the case of agriculture), make me a believer in the medium- to long-term commodities story. But I think commodity prices will fall in the near-term, particularly given slowing demand from advanced economies.

3. Hungary’s new path is the hidden danger to Europe

By Ian Bremmer, FT

The president of the Eurasia Group writes a scathing critique of Hungary’s political direction in his latest FT op-ed and asserts that the government’s efforts to wear away the country’s democratic institutions have the potential to taint the EU’s image. “The Fidesz government has leveraged its ability to warp the constitution, cementing institutional and democratic rollbacks into the rule of law. Mr Orban’s consolidation of power at the expense of democratic institutions exposes a fundamental challenge for the EU as a whole – it cannot enforce the very credo that spawned it. Hungary’s disregard for democracy and civil liberties could threaten the European brand in the eyes of potential new members and the world at large.”

EM Muser: I agree with Bremmer and have a written a number of posts on Hungary’s underlying political and economic problems. (See Hungary and Turkey: Political Parallels, Hungary’s Latest Debt Relief Plan: From Bad to Worse, Hungary’s Vicious Circle: Anemic Lending and Weak Growth, Fitch Raises Hungary’s Ratings Outlook: Odd Timing). I find Hungary’s ongoing swing away from democracy particularly unnerving considering how unnoticed it has been by the international community.

4. Colombia: Ready for the Worst

By Daniel Volberg, Morgan Stanley

Mr. Volberg  lays out two key reasons why Colombia’s economy is in relatively good shape to face global headwinds: 1) solid balance sheet (strong international reserve cushion, a modest current account deficit, and access to the IMF’s flexible credit line), and 2) significant room for monetary and fiscal stimulus.

EM Muser: This piece is short and to the point. I looked at Colombia’s economy in a recent blog post and came to similar conclusions as Mr Volberg. In addition to the excellent arguments that Volberg makes, I believe Colombia’s strong domestic demand orientation and its resilience during the height of the global financial crisis in 2008-09 also provide room for comfort. (See: How Exposed is Colombia to a China Slowdown.)

How Exposed is Colombia to a China Slowdown?

Nervousness about a China slowdown is growing. Patrick Chovanec, an economics professor at Tsinghua University, points to mounting evidence “that the fabric of China’s investment-led growth is starting to fray and unravel.”  Clearly this is not good news for the global economy, but which emerging market economies are in the direct line of fire?

South America looks quite vulnerable. China has overtaken the US as Argentina, Brazil and Chile’s top trade partner. Meanwhile, the Chinese have invested heavily in the resource-rich continent. (See Politico article: China Picks up Slack in U.S. Trade).

Regular reader Dulan has asked specifically about Colombia’s vulnerability to a China slowdown so let’s take a look.

Minimal direct exposure to China

In contrast with others in the region, Colombia remains firmly in the US orbit and does not have significant trade or investment ties to China.

Figure 1: China doesn’t rank among Colombia’s top trade partners

Source: DANE

Figure 2: Chinese direct investment in Colombia is small, particularly in comparison with Brazil

 

Source: ECLAC (Foreign Direct Investment in Latin America and the Caribbean)

Still indirectly exposed

If China loses steam, there will be global ripple effects and Colombia will not be immune. China is the second largest economy in the world and its share of global GDP reached almost 14% on a PPP basis in 2010. The IMF estimates that the impact of Chinese demand on the world’s largest economies has more than doubled over the past decade. A deteriorating outlook for Chinese imports could send commodity prices plummeting.

Oil and coal dominate Colombia’s exports, and a downturn in China will likely lead to a cutback in global energy demand. Oil prices are already on the decline, with the price of Brent crude falling below $100 per barrel this week for the first time in over 6 months.

Figure 4: Coal and oil together accounted for over half of Colombia’s total exports in 2010

 

Source: DANE 

Trade and investment ties with the US remain strong. Colombia is the third largest exporter of oil to the country, and US investors account for the bulk of Colombia’s FDI. So the bigger worry for Colombia, in relation to a China slowdown, is how much an impact it has on the US, which is already battling high unemployment and stagnating growth.

Figure 5: The US accounts for over a third of Colombia’s total FDI

 

Source: Banco de la Republica de Colombia

Good news

The good news is that Colombia’s economy is very domestic demand-oriented, with exports accounting for just 16% of GDP in 2010, which should provide some degree of insulation from global turbulence. The fact that Colombia’s banking system is healthy, with one of the highest capital adequacy ratios in the region (at 17.9% in April 2011), should also serve as a shock absorber.

Latin America as a whole contracted by 1.9% in 2009 at the height of the global financial crisis. Colombia was one of the few economies in the region that expanded on an annual basis, growing by 1.4%, which highlights its relative resilience in the face of global turmoil.

In sum, Colombia is less vulnerable to a China slowdown compared with other South American economies.