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Macroeconomic, Country Riskand Global Sector Outlook

Economic Outlookno. 1208-1209June-July 2014

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Growth: A giantwith feet of clay10 industry short stories exposemacroeconomic fragility

Economic Research

Economic Outlook no. 1208-1209 | June-July 2014 | Macroeconomic, Country Risk and Global Sector Outlook Euler Hermes

2

Economic Research Euler Hermes Group

Economic Outlookno. 1208-1209Macroeconomic, Country Riskand Global Sector Outlook

Contents

The Economic Outlook is a monthlypublication released by the EconomicResearch Department of Euler Hermes.This publication is for the clients of EulerHermes and available on subscriptionfor other businesses and organisations.Reproduction is authorised, so long asmention of source is made. Contact theEconomic Research Department Publication Director and Chief Eco-nomist: Ludovic Subran Macroeconomic Research and CountryRisk: Frédéric Andres, Andrew Atkinson,Ana Boata, Mahamoud Islam, Dan North,Daniela Ordóñez, Manfred Stamer (Coun-try Economists)Sector and Insolvency Research:Maxime Lemerle (Head), Bruno Goutard,Yann Lacroix, Marc Livinec, Didier Moizo(Sector Advisors) Support: Lætitia Giordanella (Office Man-ager), Nicolas Bargas, Sarah Bosse Platière,Clémentine Cazalets, Lucas Songeur,Ibrahim Touré, Sergey Zuev (ResearchAssistants)Editor:Martine Benhadj Graphic Design: Claire Mabille Photo credit: AllianzFor further information, contact theEconomic Research Department ofEuler Hermes at 1, place des Saisons92048 Paris La Défense Cedex – Tel.:+33 (0) 1 84 11 50 46 – e-mail: [email protected] > EulerHermes is a limited company with a Di-rectoire and Supervisory Board, with acapital of EUR 14 509 49 , RCS Paris B388 236 853 Photoengraving: Imprimerie Adelinet– Permit June-July 2014; issn 1 162–2 881◾ July 23, 2014

3 EDITORIAL

4 OVERVIEW

6 COUNTRY RISK OUTLOOK

8 SECTOR RISK OUTLOOK

10 United States: No tech bubble, but an air pocket for manufacturing

11 Mexico: The car industry under theyoke of foreign direct investments

12 United Kingdom and Ireland:The placebo effect of thepharmaceutical sector

13 France: Large export contracts -mirage or miracle?

14 Germany: Managing the digital(r) evolution

15 Italy: Is ‘made in Italy’ more than just(re) branding?

16 Eurasia: Pipelinomics is not sustainable

17 Middle East: Stress cracking in theconstruction sector?

18 China: e-commerce, catalyst orsubstitute?

19 Japan: True or fake energy?

20 OUR PUBLICATIONS

22 SUBSIDIARIES

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Euler Hermes Economic Outlook no. 1208-1209 | June-July 2014 | Macroeconomic, Country Risk and Global Sector Outlook

EDITORIAL

The seven deadly sins of growthLUDOVIC SUBRAN

The purpose of a business is to grow. This can come in manyforms— profits, revenues, market share, brand or communityinfluence. It sounds easy enough, but it's not. Underlyingfactors can make growth difficult: rapidly changing cus-tomers, a softer market, and of course fragile economic poli-cies. Today, on the macroeconomic front, it seems that there'ssome light at the end of the tunnel. Everyone has faith inbetter days to come. The problem with faith is that it is aboutbeliefs, dogmas and politics - and not about questions, results,and analytics. And when it comes to growth, there are stillmany questions to ask, results to come, and analytics to un-derstand. This is particularly true when looking at copingmechanisms across industries. From air pockets in the USmanufacturing sector to expensive energy for Japanese com-panies to the artificial reindustrialization in the UK (mainlydue to tax inversion), we identified ten micro reasons toquestion macro growth. In addition, behind our industryshort stories, there seems to be a set of common pitfalls whywe’re not seeing the recovery trickling down to companies.These are the seven deadly sins of growth:◾ Lust. After years of austerity, Europe just found aninteresting way to boost nominal GDP: to include drugs andprostitution in national accounts! Billions of dirty Euros forBelgium, Italy, and the Netherlands— but nothing for thereal economy. ◾ Gluttony. Are accommodative monetary policies aboutto end? Do we know how to wean companies from easymoney? What we do know for sure is that the risk of creditcrunch is still high in emerging Asia and Latin America, andbubbles continue to form in the US.

◾ Greed. Commodity prices have been quietly plateauing,sometimes receding. Demand for natural resources, however,is set to increase (and prices with it) with increasingly fiercecompetition over— for instance— minerals, rare earth ele-ments, and oil and gas.◾ Sloth. Reformitis seems to have become a new publicdisease, with every country competing to announce yetanother reform. The problem is how lazy reformers arewhen it comes to actually carrying out their new policies,and how loosely the reforms are often implemented. Politicalcost or lack of innovation?◾ Wrath. As we enter summer time, conflict zones aroundthe globe are heating up. Stock markets are barely moving,but for many people, suffering is very real. Meanwhile forcompanies, disincentives and risks are increasing. ◾ Envy. Fait du prince and other Acts of Gods are back onthe front burner making investment decisions— especiallycapital-intensive ones, or ones in more exotic places— muchtrickier for companies.◾ Pride. Finding solace in a low-growth-low-inflation envi-ronment is maybe the worst sin of all. Carryover debt andlack of purchasing power can be— temporarily— less of aproblem, but future generations will have to deal with them.For all of them, the devil is in the detail, but redemption ispossible— it will just be one step at a time.


4

OVERVIEW

Growth: A giant with feet of clay10 industry short stories expose macroeconomic fragility

World GDP growth isfinally gaining traction(+2.7% in 2014),allowing for a morefavorable sector outlook(34 industries withbetter risk ratings in Q2).

However, the pace of the recovery ismodest, below +3% for the third year ina row, and it remains unevenlydistributed. This limited recovery makesit complicated for several businesses togrow their topline as they face fiercerprice competition. In addition, changesof business models and more complexrisks (political, monetary, change, non-payment) continue to expose vulnerablemicroeconomic foundations.

Better prospects in advancedeconomies help improvesector risk, but vulnerabilitiesremainAdvanced economies are now expected to growby +1.8% in 2014, the fastest pace since 2010,opening the door to better sector risk assess-ments in the main countries, notably in NorthAmerica and Western Europe. In the former, de-spite a particularly weak U.S. economy in Q1due to unusually cold weather, the labor marketis improving and the unemployment rate is ex-pected to fall below 6% by end-2014, businessand consumer confidence levels are both rising,the outlook for the manufacturing sector is pos-itive and interest rates will remain at record lowlevels at least until mid-2015. GDP should growby a robust +2.9% in 2015 after +1.9% in 2014,but overly accommodative monetary policy overthe past years has raised concerns regardingpossible bubbles in some sectors (High-tech).In Western Europe, the eurozone entered a pro-gressive recovery after two consecutive yearsof recession (+1.1% in 2014 and +1.4% in 2015)and the ECB support measures have slightly im-proved expectations for 2015. The positive ef-

fects start to be visible in several sectors in theregion, most notably in Southern eurozonecountries where the competitiveness gains andthe progressive pick-up in domestic demandled to improvements in the automotive and re-tail sector. Core eurozone countries are also fac-ing the need to adjust economic models. Onone hand, Germany has to complete its indus-trial (r)evolution in order to maintain its leadingposition in manufacturing, whereas France isstruggling to sustainably boost total exports, stillheavily dependent on the performance of bigcontracts. Furthermore, the UK is set to remainone of the best performers of the region (+2.6%in 2014 and +2.5% in 2015), mainly thanks tothe recovery in financial services and the in-creasingly growth-friendly fiscal policy. However,the challenge is in attracting high-value indus-tries in order to stimulate employment and realactivity. All in all, the trend is indeed positive inWestern Europe, with 25 improved sector riskratings in H1 (and only 4 worse ratings), but thenegative effects of the 6 years of crisis have notbeen entirely absorbed: on a global scale, theregion continues to be the one with the highestrisk across all sectors, in particular with a sensi-tive or high risk profile in construction in mostof countries. In Japan, the policy-mix impact hasbeen augmented with the recent announce-ment of structural reforms, which has slightlyimproved the economic outlook through posi-

GDP growth annual change, %

ANA BOATA, MAHAMOUD ISLAM, MAXIME LEMERLE

Weights* 2013 2014 2015

World GDP growth 100 2.4 2.7 3.1

Advanced economies 62 1.3 1.8 2.2

Emerging economies 38 4.2 4.2 4.5

North America 25 1.9 1.9 2.8

United States 23 1.9 1.9 2.9

Canada 3 2.0 2.5 2.7

Latin America 8 2.5 2.2 2.7

Brazil 3 2.3 1.8 2.1

Western Europe 23 0.1 1.4 1.7

United Kingdom 3 1.7 2.6 2.5

Eurozone members 17 -0.4 1.1 1.4

Germany 5 0.5 1.9 2.0

France 4 0.4 0.7 1.2

Italy 3 -1.8 0.4 1.0

Spain 2 -1.2 0.8 1.3

Central and Eastern Europe 6 1.8 1.4 2.6

Russia 3 1.3 0.1 2.0

Turkey 1 4.0 3.3 4.2

Asia 29 4.8 4.8 4.8

China 11 7.7 7.5 7.4

Japan 8 1.5 1.4 1.2

India 3 5.0 5.6 6.1

Oceania 2 2.4 3.2 3.0

Middle East 4 2.6 3.4 4.3

Saudi Arabia 1 3.8 4.5 5.0

Africa 2 4.0 4.2 5.0

South Africa 1 1.9 2.0 3.0

* Weights in global GDP at market price, 2013Sources: IHS Global Insight, Euler Hermes forecasts


5

of asset purchases by the US Fed, but are stillexperiencing turbulences and are struggling togain momentum (+4.3%). Across core emerg-ing countries, financing costs increased on theback of more restrictive monetary policy, anddivergence remains high. Asia is benefiting fromthe positive confidence effects linked to stabi-lizing growth in China and improving economicoutlook in India due to the change in govern-ment, which has increased the attractiveness interms of capital inflows. Sector outlook remainsbroadly stable with the lowest level of risk world-wide. However, the change in China’s businessmodel has some adverse effects on several sec-tors, in particular metal, and could trigger pres-sures on other sectors due to fiercer competition(e.g. retail and e-commerce). Further, politicalturmoil in Thailand has clearly contributed toincrease the risk of domestically-oriented sectors(retail, IT services) - with the end of the Gov-

ernment's first-car buyer scheme (automotive,car component). On the contrary, countries inLatin America continue to face structural issuesdue to unresolved external imbalances, high in-flationary pressures and therefore weaker eco-nomic outlook. In particular, economic prospectshave been lowered for Brazil: +1.8% in 2014 and+2.1% in 2015, well below the 5% annual pre-crisis pace. This weighs on the overall perform-ance of the region and sector risk has shownsigns of deteriorating since the start of the year,especially for the metal industry. However, closebusiness relations with the United States benefitto some of the Latin America economies, no-tably Mexico, although this has yet to prove sus-tainable in the medium-term. In Eastern Europe,eurozone dependent economies have shown apick-up in activity, but too moderate to supportan improvement in sector risk outlook, especiallywhile being counterbalanced by the negativeeffects from the crisis between Ukraine-Russia.GDP is expected to be close to stagnation in2014 in Russia (+0.1%) and the recession inUkraine will certainly be more severe than ex-pected. In the Middle East, economic activity isset to accelerate (+3.4% in 2014 and +4.3% in2015) boosted by oil revenues that benefit theoverall sector outlook, which remains positive.However, there is a concern that the construc-tion sector, one of the main contributors to GDPgrowth, could face speculative attacks in themedium-term.

tive confidence effects (+1.4% in 2014 and+1.2% in 2015). Apart -again- from the con-struction sector, the financial situation of firmsstrengthened on the back of the rise in profits,improvement in credit conditions and support-ive fiscal measures to be implemented in thecoming months. However, one big missing pieceto the puzzle remains the lack of a clear energypolicy that would lower the energy bill, notablyin key sectors like electronics.

Emerging economies arestabilizing but adverseeffects due to capital flighthave not been fullyabsorbed Emerging economies recovered from the capitalflight shock induced by the change in the pace

-30

-20

-10

0

10

20

30

North America

Latin America

Western Europe

Central and Eastern Europe

Africa and MiddleEast

Asia-PacificQ2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q212 12 12 13 13 13 13 14 14

Total

Changes in sector risk per regionNet balance of better and worse risk ratings, quarterly data

Source: Euler Hermes

D4 D3NICARAGUA

Economic activity will be supported byongoing infrastructure projects (+4%in 2014 and +4.2% in 2015). However,external vulnerability remainssignificant.

B3 B2PORTUGAL

Domestic demand is stronger thanexpected, driven by investment. GDPis expected to expand by +1.0% in2014 and by +1.3% in 2015. A returnin confidence allowed a successful exitfrom the EU/IMF program.

A3 A2

A3 A2ITALY

Better than expected economicprospects (+0.4% in 2014 and +1.0%in 2015) will gradually benefit theprivate sector, as credit conditionsimprove and the risk of non-paymentstabilizes.

B4 B3

11 changes of country risk ratings at the end of Q2 2014

GREECE

Economic activity is stabilizing after 6years of recession while financialpressure eased significantly.Uncertainties related to the end of theEU/IMF program this Decemberremain.

SPAIN

Net exports and improved domesticdemand will boost GDP growth(+0.8% in 2014 and +1.3% in 2015).Insolvencies are expected to fall by -23% this year, for the first time in sixyears.


6

Country RiskOutlook

2014Q2 2014 — UPDATE

MACROECONOMIC RESEARCH AND COUNTRY RISK TEAM

11countries with

improved ratings

k

D4 D3NIGERIA

External liquidity indicators remaincomfortable. GDP growth expected at+6.5% in 2014 and +7% in 2015.However, medium-term challengesprevail.

D4 D3COTE D’IVOIRE

A relatively more stable politicalbackdrop allowed for economicactivity to improve (+8% in 2014 and2015) while external vulnerabilityremains subdued.

D4 D3C3 B2BB3 BB2 SERBIA

GDP growth is expected to reach+1.0% in 2014 and +1.5% in 2015. Theexchange rate has stabilized andinflation will remain low until 2015.Foreign exchange reserves areadequate.

HUNGARY

Lower inflationary pressures supportthe economic recovery (+2.5% in2014 and 2015). Macroeconomicimbalances improved with fourconsecutive years of current accountsurplus.

IRELAND

Financial independence, growing netexports and strong economicmomentum in the UK are pushingGDP growth to +2% in 2014 and+2.3% in 2015. The banking sector ison the mend.

B2 B1INDIA

GDP growth expected at +5.6% inFY2014-15 and +6.1% in FY2015-16.The newly elected government islikely to implement business-friendlyreforms. The Central Bank credibilitywill allow less pressure on prices.


7

CanadakCar component

ArgentinalCar componentlAutomobile

BrazillConstruction

& Equipment

T

& telecomk & Equipment

S

equipmentk & telecom

8


Source: Euler Hermes, as of July 16, 2014

34 changes of sector risk ratingsat the end of Q2 2014

é @ B j 6 À ‰ î ©Automobile Car component Construction Air transport Chemicals Pharmacy Agrifood Textile

North America l l l l l l l lLatin America l l l l l l l lWestern Europe l l l l l l l lCentral and Eastern Europe l l l l l l l lAfrica and Middle East l l l l l l l lAsia-Pacific l l l l l l l lSE

CTOR RISK RATINGS

END OF Q2 2014

COUN

TRIE

S W

EIGH

TED

BY T

HEIR

SHA

RE IN

REGI

ONAL

GDP

IN 2

013

13sectors withdeterioratedratings

21sectors with

improvedratings

k

lSound fundamentals; veryfavorable or fairly good outlook.

Signs of weaknesses; possible slowdown.

l

l

l

l

Structural weaknesses; unfavorable or fairly bad outlook.

Imminent or recongnised crisis.

Sector RiskOutlook

2014Q2 2014 — UPDATE

SECTOR AND INSOLVENCY RESEARCH TEAM

kl

ThailandlAutomobilelCar componentlRetaillIT Services

NorwaylComputer & Telecom

GermanykAutomobilekMachinery & Equipment

The NetherlandskAir transport

SwitzerlandkMetal

FrancelMetal

ItalykAgrifoodkRetailkComputer & telecomkMachinery & Equipment

SpainkAutomobilekCar componentkRetail

GreecekRetailkHousehold equipmentkComputer & telecom

IsraelkPharmaceuticalskAgrifoodkRetaillPaper Algeria

kCar componentkChemicals

TaiwanlConstruction

The PhilippineskAutomobile

MoroccolPharmaceuticals

South AfricalAgrifood

9


© h + Á F Ò & ∫ ¬Paper Semiconductors Metal Retail Machinery &

Equipment Aeronautics IT Services Household

equipment Computer &

telecom

l l l l l l l l ll l l l l l l l ll l l l l l l l ll l l l l l l l ll l l l l l l l ll l l l l l l l l


10

0

1,000

2,000

3,000

4,000

5,000

-2

-1

0

1

2

3

4

5

6CPI (y/y % change, rhs)Nasdaq index (lhs)

141312111009080706050403020100

Inflation rate and Nasdaq composite index

Sources: IHS Global Insight, Euler Hermes

5 years to return to pre-crisis level of employment

134

136

138

140

142

144

146

148

1413121110090807060504

Total employment3-months average, million persons


No real threat of a tech bubble The significant amounts of liquidityinjected in the US economy in therecent years did not create infla-tionary pressures but boosted eq-uity markets. Record-high marketvaluation and a (too) dynamic pri-mary market may suggest a bubbleis forming in the ICT and thebiotech sectors in the US, but, if it

does exist, it is unlikely that it wouldsuddenly burst and lead to the col-lapse of the whole sector. Indeedovervaluations are restrained tovery few players and there is no ev-idence of over-optimism concern-ing the entire industry.

A promising outlook for the ICTsectorThe ICT market in North Americaenjoys a leadership position with a31% share of the global market. Thesector benefits from a buoyant do-mestic market: IT & audiovisual percapita expenditures increased bymore than 60% between 2009 and2013 in the US. In 2013, the ICTmarket recorded a +2.8% growthrate (which was faster than theoverall US economy at +1.9%). Thissector has been a valuable driver

of growth during the past fewyears: ICT-related investments con-tributed for +0.2pp per year to GDPgrowth since 2010.

Beware of the air pocket regard-ing job creationHowever, the ICT market in NorthAmerica is mainly driven by 2 seg-ments: IT services (41%) and au-diovisual services (38%) whichrecorded the strongest growth in2013 (+4.4% and +3.8% respec-tively). The more employment-in-tensive segments are far fromproving as dynamic: telecom andIT equipment production is still be-low its pre-crisis level and audiovi-sual equipment production re-mains very weak. As it is veryunlikely that companies will repa-triate the production to the Ameri-can territory, the ICT sector cannotprovide a boost to the country’sreindustrialization. Yet, for thecountry to return to dynamic levelsof growth, job-creating industriesneed to be promoted. Indeed, theongoing decline of unemploymentrate is partly attributable to the fallof the participation rate and it wasonly in May that the economy wasable to regain all the jobs lost dur-ing the recession. Overall, we ex-pect GDP growth to approach itslong-term trend in 2015 (+2.9%),after growing by only +1.9% in2014.

CLÉMENTINE CAZALETS, DIDIER MOIZO

United States

No tech bubble, but an airpocket for manufacturing


11

0

500

1,000

1,500

2,000

2,500

3,000New registrations

Exports

141312111009080706050403020100

Car exports and new registrationsThousand of units per year

Sources: AMIA, Euler Hermes

-30

-20

-10

0

10

20

30

40

50 Automotive sectorManufacturingGDP

15141312111009080706050403020100

forecasts

Real growth rates%

Sources: Inegi, Euler Hermes

83%of automotive production

is exported

Cruising speed for the carindustryThe Mexican automotive industryhas the wind in its sails. The pro-duction of the sector has growntwice as fast (+10% per year) asworld automobile production (+4%per year) over the last decade. Mex-ico has become the 8th largest au-tomobile producer in the world,making up 3.5% of total production,and the 4th largest exporter. Thesteady increase in the rate of inte-gration of equipment further in-creases the size of the sector, with89% of the world’s top 100 suppli-

ers present in Mexico. The automo-tive industry makes up 3% of Mexi-can GDP (up from 2% in 2008) and16% of industrial production. Thistrend should continue in the fol-lowing years as a result of ongoingand announced major investments.We estimate the production of theindustry will grow by +6.5% in 2014and by +7% in 2015, much fasterthan GDP (+3.3% in 2014 and+3.9% in 2015), bringing the pro-duction capacity to 4.5 million unitsby the end of the decade, currentlyat 2.9 million in 2013.

The engines are elsewhereYet, the domestic automotive mar-ket remains small, with new vehicleregistrations below 700K per year(2.6 million in Brazil). More thanthree out of four vehicles producedin Mexico are exported, notably tothe American market. Over 70% ofvehicle exports and 90% of auto-motive equipment exports arebound for their American neighbor,where one of every ten cars soldcomes from Mexico.

Watch out for highway exitsThe rapid development by the in-dustry has been widely financed by

foreign direct investment (FDI)capital. Surely, the ambitious struc-tural reforms underway in thecountry, seeking to improve theMexican business environment,competitiveness, and internationalintegration, have had a role in at-tracting this capital. However, thenature of these FDI shows that in-vestors mainly respond to Mexico’skey position in the re-industrializa-tion underway in the US. Therefore,one should be wary of the positiveflow of these investments, as it re-veals the inherent weaknesses ofthe Mexican economy: (i) extremedependence on American activity;(ii) investment is mostly geared to-wards basic industries with lowvalue-added; (iii) risk of a suddenflight of capital with a slowdownof the U.S. economy, or as a resultof the re-location of certain indus-tries.

YANN LACROIX, DANIELA ORDÓÑEZ

Mexico

The car industry underthe yoke of foreign directinvestments


12

United Kingdomand Ireland

The placebo effect of thepharmaceutical sector

Pharmaceuticals, a strategicsector for the UK governmentThe pharmaceuticals sector, whichincludes AstraZeneca and GSK, twolabs amongst the 10 largest world-wide, is the leader in exports (7%of total exports) for the UK. Its na-tional production stands at USD 24billion. The sector is known for itsinnovation, as it boasts 25% of R&Dexpenditures (GBP 4.2 billion in2012) and employs 70K persons(0.2% of the total labor force), ofwhich over one third are in highlyskilled positions. The pharmaceu-tical sector is one of the elevenstrategic sectors for the govern-ment, along with aeronautics, au-

tomobile, nuclear, and financialservices sectors.

This does not necessarily meanthat it contributed to the eco-nomic recovery In 2013, GDP grew at its highest ratein the last 6 years (+1.7%) andshould display the strongest per-formance in the region moving for-ward: +2.6% in 2014 and +2.5% in2015. However, pharmaceuticalproduction didn’t contribute at all.Production contracted by -4% be-tween 2009 and 2013 on averageand it remains 8pp below the 2005high. Productivity losses have beenaccelerating since 2007, and ex-ports have quickly lost momentum.Due to this, the trade surplus, whichhit a peak of GBP 7 billion in 2009and 2010, has hit a low of GBP 2.8billion in 2013. As a result, the truecatalyst of the British revival since2013 has been services (notably fi-nancial services), which account foraround 80% of GDP.

The UK, a victim of the Irish fis-cal illusionContrarily to its neighbors, Irishpharmaceuticals have registeredan average annual growth of +9%

over 2009-13. This is a result of thefiscal attractiveness when com-pared to countries across the chan-nel. While corporate tax rates areat 40% in the US and 23% on aver-age in the EU, UK rates will drop to20% in April 2015, the lowest withinthe G-20. It is therefore easy toimagine Pfizer’s potential gains inmoving its headquarters from theUS to the UK had its takeover of ri-val AstraZeneca materialized. How-ever, with rates at 12.5%, Irelandpushes the British economy to itslimits. But this also increases thedependence of the country’s econ-omy on the sector: pharmaceuti-cals represent 30% of total Irish ex-ports and 27% of GDP. Thereforevulnerability is high as shown in2013 when GDP fell by 1.2% y/y dueto the expiration of multiplepatents while GNP increased by2.6% y/y.

5

10

15

20

25

30 IrelandUnited Kingdom

1514131211100908070605040302

forecasts

Pharmaceutical productionIn volume (2005 prices, USD bn)

Sources: Oxford Economics, Euler Hermes

Belgium

France

Italy

Spain

Germany

Netherlands

EU average

Portugal

United Kingdom

Ireland 12.5

21.0

23.0

23.0

25.0

29.6

30.0

31.4

33.3

34.0

Corporate tax rate%, 2014

Sources: European Commission, Euler Hermes

20%UK corporate tax rate

in April 2015

ANA BOATA, MARC LIVINEC


13

+46%Growth of turnover

for the aeronautics sectorsince 2008 whereas that of the

manufacturing industrygrew by less than 2%

0

20

40

60

80

100

Others

Aeronautics

13121110090807060504

Large export contracts in aeronauticssigned by France with emerging markets% of total

Sources: French custom services, Euler Hermes

Exports are increasinglydependent on two key sectorsDisappointing Q1 figures have con-firmed our below-consensus +0.7%GDP growth forecast for 2014. Netexports were one negative drivercontributing -0.2pp to growth, withexports showing particular weak-ness. Two reasons: first, disinflation-ary pressures are taking hold thusreducing incentives to export. In-deed, export prices have fallen forfive consecutive quarters. Second,there are only 120K French export-ing firms (vs. 300K in Germany).France is thus clearly dependent onthe export performance of largecompanies, among which aeronau-tical firms are key. This sector hasshown the best performance since2008 in terms of exports (+30%)

and the highest trade surplus in2013: EUR 22 billion, followed byagrifood (EUR 11.5 billion ).

The mirage of large export con-tracts in emerging countriesIn 2013, the sum of large exportcontracts exceeded the 2007 pre-crisis level of EUR 37.2 billion,reaching EUR 38.7 billion. Whilethis may seem encouraging, ithelps to understand the true rea-sons behind it. In 2007, economicactivity outside of aeronautics, no-tably in energy, major works, andrailways, made up 55% of total ex-ports. However, this share has beendecreasing since 2010, and is cur-rently at a meager 21% in 2013. Inreality, the growth of large exportcontracts is due to the success ofAirbus, as France is losing groundin all other sectors. The recent clos-ing of Alstom’s energy branch re-veals our struggles in developinginternational firms capable of rival-ing their competitors in tenderingseveral USD billion, which requirethe establishment of massive bank

securities. Will Alstom’s refocus to-wards transportation activities al-low it to participate in the recon-struction of the sector, or hasachieving a critical size become anecessity to do so? What else canbe said concerning the repeatedfailures with regard to Dassault’sRafale sales (defense sector), oreven the costs of Areva’s EPR (nu-clear sector) that have yet to bemastered? If we hope to return topast levels, we must use powerfulfinancial tools to catalyze the de-velopment of large internationalfirms than can help us achieve thisgoal.

FRÉDÉRIC ANDRÈS, YANN LACROIX

France

Large export contracts -mirage or miracle?

60

70

80

90

100

110

120

130

140

150

160 Wholesale Trade Construction

ManufacturingAeronauticsVehicles

14131211100908

Turnover index100= 2008

Sources: INSEE, Euler Hermes

Net exports

Domestic demand

GDP

-1

0

1

2

3

4

5

2010 2011 2012 2013 2014 2015

forecasts


GDP growth and contributions to GDP growth%

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Wages (y/y)Productivity per employee (y/y)

141312111009080706050403020100

Wages and productivity %

Sources: IHS Global Insight, Eurostat, Euler Hermes


14

+12%Increase in investment fromproducers of data processingequipment and electronics products

we expect this trend to go on in2014, boosting GDP growth at+1.9% (against +0.5% in 2013).

Industry 4.0, yet to become areality, but likely to ensuremany opportunities for the Ger-man industry After two years of decline, we ex-pect a strong rebound in invest-ment which could reach +8% in themanufacturing industry in 2014,according to the Ifo survey. The+12% increase reported by produc-ers of data processing equipmentand electronic products may be thefirst hint of the start of the indus-try’s digitalization (“Industry 4.0”).This (r)evolution should make

A shift back to domestic demandas main driver of growthSince H2 2012, corporate marginsrates have been declining (from42.2% in Q2 12 to 40.5% in Q4 13),a trend attributable to very low in-flation within the eurozone and de-clining competitiveness (deterio-rating productivity, dynamic wages,important competitive advantagesof the two main competitors -Japan and the US), which has im-pacted German exports since early2013. However, the economy reg-istered strong GDP growth in Q12014 (+0.8% q/q) on the back ofsustained domestic demand and

CLÉMENTINE CAZALETS, BRUNO GOUTARD

Managing the digital(r) evolution

products and processes smarterthrough direct communication be-tween the workforce, machines,and resources. Implementing “In-dustry 4.0” should improve com-petitiveness by securing higherproductivity and cost-cutting. Itwould also make up significantbusiness potential for already lead-ing mechanical and plant engineer-ing, for data processing equipmentand for associated services offeringbig data management and ex-ploitation.

A long way still aheadThrough long-established partner-ships between all stakeholders(companies, services, academics),leading position in manufacturing,and financial state backing (EUR 200million), German Industry 4.0 shouldsucceed in embracing the close col-laboration between a large scope ofdisciplines (electrical engineering,electronics, engineering and IT).However, this expected far-reaching(r)evolution entails risks related to(i) the plausible “shocks of culture”between all these players, (ii) heavyinvestments with a return expectedonly in the long term, (iii) the re-liance on telecommunication infra-structure and network and (iv) dataprotection.

Germany


15

70

75

80

85

90

95

100

105 Domestic demand

Private consumption

Exports

1514131211100908

forecasts

GDP components 100=Q1 2008

Source: IHS Global Insight, Euler Hermes forecasts

0

20

40

60

80

100

120

Italy

France

Germany

Revenue> Eur 50m

Revenue< Eur 50m

All companies

Index of average intangible fixed asset value*100 = Italy figures, 2012

*textile, apparel, leather, footwear, wood products and furnituremanufacturingSources: Banque de France - BACH 1 In value - aggregation of both sectors

+49%Extra-EU exportgrowth between 2009-2013for textile and furniture

Exports, the Cinderella story ofthe Italian economy Although GDP growth remainednegative over the past quarters (ex-cept in Q4 2013) on the back ofcontracting domestic demand,good news came from the contin-ued positive trend in exports, whichprovided the highest contributionto GDP growth for the third con-secutive quarter in Q1 2014. Italianexports are among the most diver-sified worldwide in terms of prod-ucts, while the exposure outsideEurope is strengthening (46% of to-tal exports compared to 37% inSpain and 40% in France). In par-ticular, exports to emerging coun-

tries showed strong performanceover the past 12 months (+8% y/yon average compared to +2% forexports to the advancedeconomies).

The magic of “Made in Italy”still in effect overseas Textile (apparel, leather, footwear)and furniture manufacturing areplaying a crucial role in this overallpick-up in exports, making up morethan a quarter of the growth postedin 20131, while accounting for only11% of total exports. These indus-tries have made such a dramaticinroad in extra-EU markets (+49%over 2009-2013 and +8% last year)that the European Union was thedestination for only half of their ex-ports.

But the magic could run out ifcounterfeiting is not foughtHigh standard of quality, excellentdesign as well as innovation arestrongly associated with the label“Made in Italy” in textile / furniture

ANA BOATA, BRUNO GOUTARD

Is ‘made in Italy’ more thanjust (re)branding?

manufacturing. Average intangiblefixed assets per company (sup-posed to encompass brands andpatents among other things) inthese sectors outline Italian domi-nance as they are around 2.5 timeslarger than those in France andGermany. Moreover, Italian SMEsin these sectors are largely aheadof their French and German coun-terparts on the same criteria. How-ever, counterfeiting may wreakhavoc in this successful businessmodel, depriving Italian companiesof revenue, and above all tarnishingthe brand due to poor qualitygoods. Therefore, protecting Italianintellectual property capital, espe-cially in emerging markets, shouldamount to a national cause. In thisrespect, the EU Action Plan on en-forcement of Intellectual PropertyRights recently announced by theEuropean Commission is welcome.

Italy


16

0

2

4

6

8

10

12

Gas imports

Pipeline transit fees

1312111005

Ukrainian transit fees and gas imports % of GDP

Sources: SSCU, IMF, Euler Hermes

1.9%of Ukraine’s GDP

for transit receipts

1 Thousand Cubic Meters

tcm from Ukraine since earlier gasprice discounts have been can-celled in the wake of the ongoingconflict between the two countries.As a result, the gas import bill hasrisen from 3.5% of GDP in 2005 to7% in 2013.

Pipelines: dwindling impor-tance?For two decades, Russia has sup-plied the EU with 27% of its gas con-sumption. Thereby 80% of its ex-ports have passed Ukraine, usingthe two major Brotherhood andSoyuz pipeline systems. Today,Russian gas supply through Ukrainehas fallen to around 60% since theNorth Stream pipeline joining di-rectly Russia and Germany underthe Baltic Sea became operationalin 2011. It might drop to 30% by2016 if the South Stream pipelineunder the Black Sea goes on line asscheduled. The combined capacityof the North Stream and SouthStream pipelines would be roughlyequivalent to the amount Russiacurrently exports to the EU.

Clinging to the gas transitmonopoly, a pipe dream Owing to North Stream’s comingon line and because the fee for gastransit through Ukraine hasincreased more moderately than

Gas imports: high dependenceand rapidly rising billUkraine’s dependence on gas im-ports from Russia − accounting forabout 60% of its gas consumption– has remained high and nearly un-changed over the past 20 years, be-cause it has hardly restructured itsenergy-intensive manufacturingsectors. Today, Ukraine’s economyis three times more energy-inten-sive than Poland’s and 25% morethan Russia’s. Moreover, the pricefor imported gas from Russia hasrapidly increased from just USD 50per tcm1 until 2005 to over USD400 per tcm in 2013. Currently Rus-sia is asking for almost USD 500 per

MARC LIVINEC, MANFRED STAMER

Pipelinomics is not sustainable

gas prices, from USD 1.1 per tcmper 100km in 2005 to USD 3.1 in2013, total transit receipts havefallen from 2.3% of GDP in 2005and a peak of 2.5% in 2010 to 1.9%in 2013. The outlook for thepipeline sector is bleak as Russia’sreliance on Ukraine as a transitcountry is likely to fall further withthe eventual completion of SouthStream. Ukraine needs to restruc-ture in this regards as well. And itmust get along with its neighbor asit needs Russian gas.

Eurasia

0

50

100

150

200

250

300

350

400

450UkraineUnited KingdomGermany

131211100908070605

Gas pricesUSD/tcm

Sources: IMF, Euler Hermes


17

Qatar

United Arab Emirates

Oman

Egypt, Arab Rep. 6.3

7.5

10.8

12.2

Sources: Oxford Economics, Euler Hermes

Value-Added output in the construction sector% of real GDP in 2014

85

90

95

100

105

110

115

14131211100908

Housing consumer Price IndexDubai, 100=2007, NSA


15,694 Real estate transactions

in Dubai in Q1 2014

ANDREW ATKINSON, DIDIER MOIZO

could impact adversely on the con-struction sector and thereby onoverall growth.

…and the UAE have been therebeforeIn Dubai, which experienced a se-vere property-related crisis in 2009,the number of property dealingsincreased by 11% in Q1 2014, toreach 15,694 real estate transac-tions. Property prices, again, aresoaring, with an increase of 43% forsome units in 2013. As with thefootball World Cup in Qatar, con-struction activity in Dubai has beenspurred by the Emirate's success inNovember 2013 in being awarded

The construction sector helpsdrive GDP growthGrowth in the construction sectorin many countries in the MiddleEast continues to be rapid. Infra-structure and housing needs areboosted by significant demo-graphic changes and urbanization,political will and financial resources.Growth in the construction sectoris an important positive contributorto overall economic growth. How-ever, this virtuous circle involvessome potential risks as a construc-tion boom could turn in risks, in-flated by speculative forces, and acorrection of this, whether by man-aged correction, raises questionsover the sustainability of currentrelatively high overall GDP growthrates.

Qatar is a leading example... Through the Qatar National Devel-opment Plan Vision 2030, thiscountry has significant ambitionsreliant on inputs from the construc-tion sector. However, there havebeen recent questions raised overwhether Qatar should be allowedto host the football World Cup in2022, given uncertain bidding pro-cedures. Restricted (or cancelled)revenue streams from this interna-tional event would not cause a sys-temic crisis for state finances but

Stress cracking in theconstruction sector?

◾Construction sector hasbeen growing rapidly, en-abling relatively strong GDPgrowth rates, particularlyin the GCC countries. Thereis concern that speculativeforces could result in risksfor real estate.

◾The GCC economies areunlikely to be destabilisedbut investor confidencemay be dented at a timewhen Qatar and the UAEhave been re-categorisedfrom frontier to emergingmarket status.

the organization of the 2020 Expo.In addition, rents in Dubai have alsoincreased significantly and thereare concerns relating to the poten-tial for a real estate speculative bub-ble. It should be remembered thatbetween 2008 and 2011 the realestate market collapsed with someprices falling by up to -60%. Cur-rently, Dubai's stock market is downby around 25% since mid-May,partly reflecting a sell-off in real es-tate stocks and, in particular, un-certainties relating to a leadingconstruction group.��

Middle East


18

0

1

2

3

4

5

6

0

1

2

3

4

5

6

7

8

9

10

11

12Private consumption growth, % (rhs)

Online retail sales (% GDP, lhs)

151413121110

Private consumption and online retail sales

Sources: National data, Euler Hermes

USD550 bn Online Retail Sales

in 2015

A good combo: A wealthier con-sumer and an increasingInternet penetration rateA perfect storm of conditionsseems likely. First, Chinese personalincome is growing rapidly, withwages projected to increase by+11% in 2014. Second, opportuni-ties for the sector are large as thereach of the Chinese internet con-tinues to grow. At the end of 2013,internet usage rate hit 45.8% of thepopulation in China with 54 millionnew users, which places it at a mid-point between emerging countries(32.4%) and developed countries(78.3%). The worldwide pursuit ofincreasing this rate, including in de-veloped economies (3pp per year),sparks the hope of potentially dou-bling current levels in China with422 million additional new users.

Substitution effect or valueadded?Similarly to America and other pi-oneers of e-commerce, China islikely to experience a substitutioneffect between traditional retailsales and online retail sales, withoutcreating any significant true value,as e-commerce has proven to bethe demise of in-store retail sales.In addition, it requires investmentsthat firms with low profit marginscannot afford, as they promote adownward pressure on prices that

e-commerce: Private consump-tion driverIn 2013, China became the largestmarket for online retail sales (USD297 billion, or 3.2% of GDP), beat-ing out the US (USD 262 billion),and future prospects look prom-ising. In 2015, the market looks tomake up 5% of GDP with USD 550billion, which would help acceler-ate the government's plan of shift-ing the Chinese economy fromexport-led growth towards house-hold consumption driven growth.In addition, it would also benefitthe growth of certain sectors suchas logistics, packaging, inventorymanagement, data processing,computer security, and the designand management of internet por-tals.

MAHAMOUD ISLAM, DIDIER MOIZO

cannot be absorbed by a majorityof Chinese companies. Lastly, e-commerce can also hurt local firms,ranging from production to retailsales, as it decreases the influenceof national borders and increasescompetition between countries.This allows neighboring countrieswith a comparative advantage,such as Vietnam, to offer the sameproducts at cheaper prices. As a re-sult, certain Chinese markets, suchas the one for electronic compo-nents, could suffer in the long run.

China

0

10

20

30

40

50

60

70

80World Emerging economies

Advanced economies

China

14131211100908070605

Internet usage rate% of total population

Sources: International Telecom Union, Euler Hermes

e-commerce, catalyst or substitute?


19

70

80

90

100

110

120

130

0

2

4

6

8

10

12

14

16

18JPY per USD (lhs) Gas price (rhs)

14131211100908070605Sources: BP, Euler Hermes

Gas price in JapanUSD/Mbtu

0

50

100

150

200

250

300

Gas

Oil

Coal

14f1312111009080706050403020100

Energy import billUSD bn

Sources: Chelem, ITC, Euler Hermes+17%Rise in electricity costsbetween 2010 and 2013

Electronics and paper, twostruggling sectors despite therebound in growthJapanese growth is expected at+1.4% in 2014 and +1.2% in 2015,above its long term average, drivenby a pro-growth “policy-mix”. Thisperformance may get weaker, dueto cost constraints on several elec-tric-intensive industries in Japan,particularly the manufacturers of

electrical appliances, electricalequipment, and paper suppliers.Japan is usually at the mercy of vari-ations in energy costs. Ever sincethe Fukushima nuclear disaster in2011, the country has seen its en-ergy imports rise by +41% to USD262 billion between 2010 and2013. At the start of this year, theseimports accounted for one-third ofJapanese total imports. The shut-down of its 54 nuclear reactors,from which came around 30% ofJapanese total electricity, hasbrought on the cost of electricity tosoar by +17% over the 2010-2013period. This in turn has raised by+35% the production costs of sili-con required in the manufacturingof any electrical component. Simi-lar effects apply for the Japanesepaper industry. The rise in electricitycosts has greatly increased the costof its paper production; it has hitUSD 660 a ton on average in 2013,compared to USD 580 in Europe,and half of that in Russia.

Profit margins subject to severeenergy cost pressureParticularly for these two sectors asfor those requiring a significant sup-

MAHAMOUD ISLAM, MARC LIVINEC

True or fake energy?

ply of electricity (such as metallurgyand chemicals), downward pres-sures on their profit margins will bestrong. On the demand side, world-wide growth should remain mod-erate at +2.7% in 2014, still below+3%, thus limiting the rise in exportoutlets. On the supply side, in addi-tion to higher material costs, thesesectors have to cope with the shockwave of a changing foreign ex-change rate -with ambiguous ef-fects- and growing salary costs atthe same time. In order to maintaingrowth, Shinzo Abe's governmenthas had to proceed with an aggres-sive monetary policy, inducing astrong depreciation of the yen (-15%since December 2012). While thispolicy may have stimulated Japan-ese exports by raising their com-petitiveness (+2% and +4% in 2013and 2014), the downside lies in therise in supply costs for the Japaneseindustry). In addition, rising infla-tion and a strong improvement inthe labor market exerts an upwardpressure on salaries and com-pounds the production costs ofJapanese industries.

Japan

https://www.youtube.com/watch?feature=player_d

WeeklyExport RiskOutlook

http://www.eulerhermes.com/economic-research/economic-publi-NN


20

1

Business Insolvency Worldwide

Economic Outlookno. 1200-1201october-november 2013

www.eulerhermes.com

Economic Research

Patching things upFewer insolvencies, except in Europe

B 18/12/13 17:23 Page1

Economic ResearchEuler Hermes Group

Economic Outlookand otherpublications

Already issued:

no. 1187 ◽ Special Report The Reindustrialization of the United States

no. 1188 ◽ Special Report Transport: A two-speed world

no. 1189-1190 ◽ Macroeconomic, Risk and Insolvency Outlook World heads for sixth year of crisis: Something the Maya did not forecast!

no. 1191 ◽ Global Sector Outlook Now where did global demand go?

no. 1192 ◽ Special Report Trade Routes: What has changed, what will change

no. 1193 ◽ Macroeconomic, Risk and Insolvency Outlook Europe: Still looking for a second wind

no. 1194 ◽ Business Insolvency Worldwide Corporate insolvencies:The true nature of the eurozone crisis

no. 1195-1196 ◽ Macroeconomic, Risk and Insolvency Outlook The world at a crossroads

no. 1197 ◽ Global Sector Outlook Reconciling economic (dis)illusions and financial risks

no. 1198 ◽ Special Report The Mediterranean: Turning the tide

no. 1199 ◽ Macroeconomic and Country Risk Outlook Half-baked recovery

no. 1200-1201 ◽ Business Insolvency Worldwide Patching things up: Fewer insolvencies, except in Europe

no. 1202-1203 ◽ Macroeconomic and Country Risk Outlook Top Ten Game Changers in 2014: Getting back in the game

no. 1204 ◽ Global Sector Outlook All things come to those who wait: Green shoots for one out of four sectors

no. 1205-1206 ◽ Macroeconomic and Country Risk Outlook Hot, bright and soft spots: Who could make or break global growth?

no. 1207 ◽ Business Insolvency Worldwide Insolvency World Cup 2014: Who will score fewer insolvencies?

no. 1208-1209 ◽ Macroeconomic, Country Risk and Global Sector Outlook Growth: A giant with feet of clay

To come:

no. 1210 ◽ Special Report

Macroeconomicand Country Risk Outlook

EconomicOutlook no. 1199September 2013

www.eulerhermes.com

Half-baked recovery

Economic Research


EconomicOutlook no. 1202-1203December 2013-January 2014

www.eulerhermes.com

Top Ten Game Changersin 2014Getting back in the game

Economic Research

TheEconomicTalk

http://www.eulerhermes.com/economic-research/economic-publications/Pages/Weekly-Export-Risk-Outlook.aspx

https://www.youtube.com/watch?feature=player_detailpage&v=EhZaQnqR3TE


21

◽ Road transport: Labor costs explain the large gap in profitability inEurope > July 8, 2014 (En, Fr)◽The European electricity market under strong pressure > July 5, 2014(En, Fr)◽Thailand: Another coup challenges the country’s economicresiliencel > June 6, 2014 (En)◽2014 World Cup : more inflation than growth in Brazil > June 6, 2014(En)◽Tire industry on a roll > April 17, 2014 (En, Fr)◽Putinomics: Tightrope walking > April 10, 2014 (En)◽Renzimania: Will charm survive tough reforms? >April 9, 2014 (En)◽The reindustrialization of the U.S.: A 2014 update > April 2014, 2 (En)◽Fewer non-payments in 2013for Italian companies, but moresevere > February 19, 2014 (En)◽China: 6 firms out of 10 managed to reduce their payment terms in2013 > February 17, 2014 (En)◽The Fragile 10: Turbulences but no crash > February 6, 2014 (En)

EconomicInsight

◽Belgium > 2014-06-30◽Burkina-Faso > 2014-06-30◽Chile > 2014-06-30◽China > 2014-06-30 ◽Colombia > 2014-06-30◽Cote d'Ivoire > 2014-06-30◽Croatia > 2014-06-30 ◽Czech Republic > 2014-06-30◽France > 2014-06-30◽Germany > 2014-06-30◽Greece > 2014-06-30◽Hungary > 2014-06-30◽India > 2014-06-30 ◽Ireland > 2014-06-30◽Italy > 2014-06-30◽Malaysia > 2014-06-30◽Morocco > 2014-06-30◽Namibia > 2014-06-30

◽Nicaragua > 2014-06-30◽Nigeria > 2014-06-30◽Panama > 2014-06-30◽Peru > 2014-06-30◽Poland > 2014-06-30◽Portugal > 2014-06-30◽Senegal > 2014-06-30◽Serbia > 2014-06-30◽Singapore > 2014-06-30◽South Africa > 2014-06-30 ◽Spain > 2014-06-30◽Tanzania > 2014-06-30◽Thailand > 2014-06-30◽Turkey > 2014-06-30◽United Arab Emirates> 2014-06-30◽United Kingdom > 2014-06-30◽United States > 2014-06-30

CountryReport

◽Machinery and Equipment in Italy: Preparing its comeback > 2014-06-23(En)◽Pharmaceuticals in China: At full volume > 2014-06-24 (En, Fr)◽High-Tech in the Netherlands: A gem at the heart of Europe > 2014-04-29 (En)◽Pharmaceuticals in Russia: A high-growth market mainly benefiting Western laboratories (untilnow) > 2014-04-18 (En, Fr)◽The chemicals industry in Germany: Challenging times ahead despite a recent gasp of relief> 2014-04-15 (En)◽The Italian wine industry: In vino veritas, leading the way out of the crisis > 2014-04-15 (En, It)◽Baumärkte Deutschland : 2014 - noch ein verregnetes Jahr ? > 2014-04-18 (De)◽ Secteur de la construction en France: valoriser un potentiel de croissance en accélérant la sortie decrise> 2014-03-26 (Fr)◽Automobile sector in China: A multitude of small local players dominated by wester businesses>

2014-01-22(En)

IndustryReport


EconomicOutlook no. 1205-1206March-April 2014

www.eulerhermes.com

Hot, brightand soft spots:Who could make or breakglobal growth?

Economic Research

Global Sector Outlook

Economic Outlookno.1204 February 2014

www.eulerhermes.com

All things cometo those who waitGreen shoots for one out of four sectors

Economic Research

1 06/03/14 18:49 Page2

Business Insolvency Worldwide

Economic Outlookno. 1207May 2014

www.eulerhermes.com

InsolvencyWorld Cup 2014: Who will score fewer insolvencies?

Economic Research


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