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Investment Research — General Market Conditions

This note summarises the observations from our attendance at the IMF’s annual

meetings, where we met with 20 IMF mission chiefs on advanced economies and emerging

and frontier markets. We wish to thank all of our hosts for their time and for the constructive

and open nature of the discussions, which we found invaluable. The views set out in this

note are our own.

While seeing a modest recovery, the IMF appears quite concerned about the medium-

term outlook in many advanced economies. In the eurozone, many countries have not

used the window of opportunity offered by loose monetary policy to undertake wide-

ranging structural reforms. Many of the heavily indebted southern European countries

(notably Italy) are vulnerable to rising interest rates given the very weak growth outlook.

Many of the same concerns go for Japan.

Meetings on emerging markets were generally more positive, especially for key

emerging markets such as Russia, Mexico and Brazil, where the IMF praised the

implementation of orthodox and prudent macroeconomic policies, which have helped boost

an economic recovery in these economies. The IMF seems clearly concerned about

increasing financial risks in China. While it does not see an immediate crisis, there is an

urgent need that the Chinese authorities take steps to address the vulnerabilities.

The IMF sees a two-speed economic development in Africa currently. The continent’s

big commodity-producing countries, Nigeria, Angola and South Africa, are struggling and

need structural adjustment to cope with the ‘low for longer’ outlook for commodity prices.

However, in oil-importing African countries, economic growth continues to be solid, due

to the expansion of public investment, regional integration and population growth; notably,

Kenya, Tanzania, Rwanda and Uganda are doing particularly well.

IMF more upbeat on big EMs while turning cautious on advanced economies

Source: IMF, World Economic Outlook (WEO) April and October 2016, Danske Bank Markets

-1

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Global US Eurozone UK Japan EM China Brazil Russia

%2017 GDP growth forecasts

April October

17 October 2016

IMF Annual Meeting Special

Emerging markets set to be main driver of global growth

Head of Emerging Market Research Jakob Ekholdt Christensen

+45 30584714 [email protected]

Senior Economist, Trading Desk Strategist Vladimir Miklashevsky

+358 10 546 7522 [email protected]

mailto:[email protected]

2 | 17 October 2016 www.danskeresearch.com

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World economic outlook – emerging markets set to be main

driver of global growth

The outlook for the global economy points to subdued economic growth. Emerging

markets are dominating the world economy increasingly. Indeed, the main reason behind

the increase in global growth over the next five years is the increasing weight of relatively

fast-growing emerging markets. There are encouraging signs of recovery in many of the

badly hit emerging markets, such as Russia and Brazil, which should make an important

contribution to global growth in the next five years. There are fewer worries about China

in the short term but more concerns about the medium term. Advanced economies will only

contribute very remotely to the pickup in growth.

From a structural perspective, the IMF is concerned about the slowdown in

productivity and the impact of an ageing population notably in advanced economies.

Potential output is declining in many countries, notably in the hardest hit crisis countries,

where potential output is falling towards actual output rather than the other way around.

Given weak growth and inflation pressures, the World Economic Outlook (WEO) assumes

that short-term rates will remain very low in the euro area and Japan until at least 2020.

Another major concern of the IMF’s is the slowdown in trade. A study by the IMF finds

demand and its composition explain 80% of the slowdown in trade over the past few years

(see the graph below) – importantly the sluggishness of investments in recent years, which

are typically quite trade intensive compared with consumption. The decline in the global

value chain explains another 10% of the decline, while protectionism and trade restrictions

account for the rest. A rise in global protectionism is a key risk to the world economy.

Low inflation presents a significant challenge to policymakers in advanced economies.

The decline in inflation goes beyond the commodity price fall. Persistent economic slack

also plays a significant role in pushing down inflation. Furthermore, the IMF finds that the

fall in inflation expectations is bigger in countries where monetary policy is seen as

constrained. Although inflation may pick up due to higher commodity prices and less slack

in many countries, the IMF advocates policy actions based on ‘three Cs’: comprehensive,

co-ordinated and taking into account the circumstances, both inside and across countries.

Global trade has been slowing sharply in recent years

Source: Macrobond Financial, Danske Bank Markets


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Eurozone – significant IMF concerns about the outlook

The meetings on the eurozone were the most concerning. Although the IMF staff sees a

modest economic recovery continuing, the string of legacy issues from the financial crisis

(banking sector problems, structural obstacles, high public debt and demographic

challenges amid waning political support) points to a very weak growth outlook, hindering

a significant reduction in unemployment.

The IMF views a policy mix relying too much on expansionary monetary policies. Both

monetary and fiscal policy options are now quite limited if the eurozone were to be hit by

a negative shock. Furthermore, many southern European countries (notably Italy, see

below) are vulnerable to rising rates in Europe if inflation picks up and monetary policy

tightens, given the countries’ weak growth outlook and high debt levels.

Limits of monetary policy are close to being reached. Negative interest rates are close

to the lower bound. Specific features in the eurozone make negative rates more challenging

than in, for example, Denmark and Switzerland. One example is the TARGET2 system,

where excess liquidity typically ends up in well-performing countries such as Germany and

the Netherlands, whose banks then pay a disproportionally high price for negative rates.

An expansion of securities purchased could be considered but expanding to equity while

may meet political resistance. Similarly, a yield target as with Japan would be complicated

operationally, with 19 different yield targets.

The IMF sees a remit in using fiscal space to boost growth prospects in the eurozone.

However, the fiscal space is quite limited in most countries; Germany, with the only really

significant space, could expand fiscal policy by around 0.5% of GDP but this would benefit

mainly Germany through higher potential growth and not the rest of the eurozone, given

the limited trade and direct investment linkages. The IMF sees virtue in expanding the

Juncker plan but, so far, the plan has been too slow moving with only EUR100bn approved

in the project.

Structural reforms have fallen short of expectations. Countries have generally not taken

advantage of the loose monetary policy to undertake structural reforms. In IMF

programmes, the provision of relatively cheap money normally comes with strict

conditionality. Admittedly, there have been some success stories: Ireland, Spain and

Portugal.

European banking system is structurally weak. Europe is overbanked and there is a need

for banking consolidation. Furthermore, the return on equity is low, with a large number of

non-performing loans (NPLs) burdening banks’ balance sheets.

Political challenges are significant. The refugee problem has challenged the unity in the

EU and could spill over to economic performance if there are significant restrictions on the

free movement of labour and with goods under pressure. Brexit presented another

significant challenge and there are clear risks for a hard Brexit at this point.

Modest pickup in real GDP growth and

inflation

Source: IMF, WEO October 2016, Macrobond

Financial, Danske Bank Markets

Eurozone countries expected to see

sizeable cuts in government

expenditure…



…leading to lower fiscal deficits while

current account surpluses remain

high…



…but public debt levels are reduced only

modestly




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Italy – a challenging cocktail of high debt and low growth

The IMF’s main concern on Italy is the weak growth outlook. The IMF projects

economic growth at around 0.9% until 2021. Italy has fallen behind the rest of the eurozone

(its per capita level is at the same level as in 2000). Lower productivity growth requires

low wage growth or higher unemployment.

The high debt level is a serious concern and could prompt challenging debt dynamics.

The country needs to maintain very high fiscal primary surpluses to reduce debt – 3.5% of

GDP compared with 1.5% of GDP currently. This raises a number of critical questions:

will the government be able to achieve the necessary fiscal adjustment? Is there political

consensus to maintain such high surpluses for several years? What happens if interest rates

rise as part of a normalisation of monetary policy in Europe? In a way, the current outlook

is in that sense ‘the best of all worlds’, as Italy has benefited from low interest rates,

improved terms of trade and plentiful liquidity in the banking system.

The IMF acknowledges reform efforts under the current government, but sees a need

for further reforms. In the IMF’s view, the government has tried to do as much as it can.

For example, the labour reform was very good but the positive impact will be felt only over

time as it applies only to new contracts. The IMF thinks that additional reform efforts are

required. For example, wage bargaining needs to be made more flexible, also in the public

sector. The judicial system also needs upgrading.

On the fiscal side, the authorities have to tread a fine line between pursuing fiscal

consolidation and limiting the impact on economic growth. Hence, a more ‘pro-growth

friendly’ fiscal policy mix is needed. Italian tax rates are very high and the proposal in the

budget for 2017 to lower corporate tax is welcome. However, the proposed increase in the

deficit to 2.4% of GDP, compared with the 1.9% of GDP envisaged, could further

complicate reducing debt.

The health of the banking system is the Achilles heel of the Italian economy. The

financial sector has a lot of NPLs, undermining the ability to lend to the private sector.

Hence, reforms are necessary. Overall, with 640 banks, there is scope for consolidation. At

the same time, complications arise from the politically difficult to implement bail-in rules.

Many Italian banks will have problems coping with negative interest rates. The IMF

has produced a paper that divided Italian banks into three tiers. The top-tier banks could

survive negative interest rates. The medium-tier banks suffer from low profitability but

could survive the negative rates if they cut expenditures. However, the lower-tier banks

will struggle even under a variety of favourable assumptions.

Growth and inflation pressures remain

very weak



Therefore, despite sizeable projected

cuts in public expenditures …



...public debt is set to remain at a high

level




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Spain– a bright spot in the eurozone

In many of our meetings on the eurozone, Spain came up as the bright spot. The

country is seeing quite strong growth and has been one of most reform-friendly countries.

So far, the lack of government has not affected Spain’s economic performance but the

political vacuum has delayed implementation of new reforms.

In its latest WEO projection, the IMF raised its growth forecast for the Spanish

economy. Real GDP growth was revised up to 3.1% (from 2.6%) for 2016, as H1 was

better than projected. As such, the negative impact of political uncertainty and Brexit has

not materialised while activity has also been boosted by low interest rates and a rise in

tourism due to geopolitical concerns elsewhere. The IMF estimates that structural reforms

have paid off, raising the growth rate by 0.5pp. Spain had also benefited from external

tailwinds from low interest rates, pushing down variable mortgage rates. However, the

IMF team sees a moderation next year to 2.2%, declining further to 1.5% over the

long term.

The IMF calls for additional reforms to strengthen growth prospects. Focus should be

on the SME sector, notably making it more subject to competition. While the Spanish

government has adopted a market unity law, in practice the reform has not been

implemented fully, as many laws still have to be passed. There is also a need to liberalise

certain professions and strengthen investment in research and development, especially on

the private side.

The Spanish labour market is still suffering from a large split between temporary and

permanent workers and too little investment in training. Firm level bargaining needs to

be strengthened. As a result, the IMF estimates structural employment to be around 16%.

Long-term unemployment is a significant problem, with 40% having been unemployed for

more than two years and 60% for more than a year.

Ironically, the fiscal position has turned out relatively strongly with the caretaker

government in place. The fiscal deficit is expected to be 4.5% of GDP this year, down

from 5.0% of GDP last year and falling to 3.0% in 2017. The positive performance this

year has been attributed partly to a one-off due advance payment of corporate income tax

(CIT). This would also help in lowering the deficit in 2017. The IMF is projecting that

public debt will peak at 103% of GDP next year, falling to 97% of GDP in 2021.

Externally, the IMF sees the Spanish real effective exchange rate as overvalued.

Further wage containment is still needed, despite the current account balance improving

from a deficit of 10% of GDP before the crisis to a surplus (for the first time since 1990).

However, Spain is still suffering from a stock problem, with high private and public

external debt with an NIIP (net international investment position) at -90% of GDP. Hence,

while the private sector has reduced its leverage, this has been offset by an increase in

public debt, where half is held by foreigners. Hence, there is a need to maintain current

account surpluses in order to bring the NIIP down to -70% by 2021.

Spain has been quite successful in implementing banking sector reforms. Global

players, such as Santander, generate almost two-thirds of income from abroad. The main

challenge is for domestically-focused banks. Smaller and medium-sized banks have the

biggest share of NPLs but, on average, Spain has higher provisioning than other countries.

A temporary rebound in economic

growth…



…has together with cuts in government

expenditures…



…led to a sizeable reduction in fiscal

deficits, although public debt remains

high




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Japan – temporary boost to economic growth

The IMF has revised up its growth forecast for next year due to the postponement of

fiscal consolidation. The Japanese economy is now expected to grow by 0.6% in both

2016-17. For 2017, this is a significant upgrade of the growth outlook, as the IMF expected

growth to fall by 0.1% in the April WEO outlook. In 2016, there has been no fiscal

consolidation and there will be less consolidation next year.

The monetary policy rate may be moved to positive levels in 2017 but the 2% inflation

target will be difficult to reach anytime soon. Steepening of the yield curve is more

important than the level of negative interest rate. The Bank of Japan (BoJ) has moved away

from quantitative targets to a yield target. There could be an asymmetric response, lowering

the yield curve if a negative shock arises. Markets seem to have lost belief in the BoJ,

although the IMF believes there could begin to be wage pressures due to shortages in certain

areas of the labour market. ‘Helicopter money’ would necessarily be effective as the

multiplier could be pretty small, as people would save their central bank-funded

government vouchers.

On the fiscal side, the structural deficit remains high at 5% of GDP. According to the

IMF, the cost of less fiscal adjustment in 2016-17 will be more fiscal adjustment down the

road. This implementation of the higher consumption tax will weigh on economic growth,

meaning it will be difficult to reach potential growth, which is projected to decline to zero

in 2030 due to demographics. This includes relatively high productivity growth over the

next five years, offsetting the declining labour force (even taking into account more

women): productivity growth can be boosted by easy adoption of technologies as done in

the past.

The IMF sees three important reform areas: trade, service sector and labour sectors.

Labour reforms should promote more female participation and immigration (more cultural

and political – being done in certain sectors). The IMF estimates that Japan would need

230,000 people per year to deal with shortages. Service sector reforms should also be on

the agenda. However, it is likely that there will be an election in January 2017 for the lower

house in parliament. Few reforms would probably be adopted prior to elections but there

could be a reform push with reform-minded people coming into government.

Debt dynamics are worrying. With reliance on fiscal and monetary policy, a non-linear

outcome could loom. A worst-case scenario would see households becoming increasingly

concerned about fiscal sustainability, being less likely to pay their social security

contributions and starting withdrawing banking deposits. However, such a scenario is not

expected to materialise soon.

Banking profitability has been under pressure but that has been the case for a long time.

The IMF noted that many Japanese banks have moved operations abroad, which has held

up earnings.

Potential economic growth remains

low…



…while fiscal deficit prevails



External position remains solid…



…while public debt keeps rising




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China – rising financial risks prompting calls for action

The IMF generally sees the rebalancing of the Chinese economy as being underway

but causing uneven and slower growth. It projects real GDP growth of 6.6% in 2016,

slowing to 6.2% in 2017. However, unless reforms are carried out, the medium-term

outlook will look increasingly weak.

The IMF has become more concerned about financial risks in the Chinese economy

recently. Funding issues related to a sharp rise in short-term intra-financial sector lending

present risk to the financial system. Furthermore, credit to the private sector is growing

very rapidly and there are questions about the quality of credit. As savings are significant

for households and the capital account remains closed, money is chasing investments,

increasing the risk of asset price bubbles. One of the areas is house prices, where the IMF

is concerned about the speed of the increase.

The IMF, therefore, sees a need for decisive action to tackle the rising vulnerabilities.

Among the required measures is encouraging banks to recognise more proactively loan

losses and strengthen capital ratios. Furthermore, there is a need to upgrade the supervisory

framework to foster better cross-agency information sharing and policy co-ordination,

reducing the scope for regulatory arbitrage and enhancing crises management capabilities.

In the corporate sector, the Chinese authorities should harden budget constraints on SOEs

and move ahead with restructuring and liquidating over-indebted firms.

On fiscal policy, the IMF generally recommends the need to reduce the augmented

deficit. Focus should be on building an adequate safety net, including targeting social

assistance for displaced workers and providing restructuring funds for banks while

reducing infrastructure investments and inefficient spending.

On data quality, the IMF sees some evidence pointing to a possible overstatement of

growth recently. However, the overstatement is likely to moderate and the official national

accounts data, while there is much room for improvement, is likely to provide a broadly

reliable picture.

China’s growth is set to slow down…



…while the fiscal deficit is set to prevail

Source: IMF WEO October 2016, Macrobond


Current account surplus stays strong…



...while public debt is rising, although

from low levels




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Russia – cautious positivity

The IMF generally praised the macroeconomic response by Russia to the sizeable dual

shocks from falling commodity prices and sanctions. The co-ordination between the

central bank and the Ministry of Finance has been noteworthy. Going forward, a

simultaneous monetary easing and fiscal tightening is needed.

The IMF has revised up its 2016 and 2017 GDP outlook for Russia: it now expects -

0.8% y/y (previously -1.0% y/y) and 1.1% y/y (previously 1.0% y/y), respectively. The

potential growth in GDP is 1.5% y/y. Meanwhile, it has revised down the inflation

trajectory. While supply-side numbers growth appears to be solid, the demand side

continues to stay negative. Non-energy exports are expanding slowly.

One of the biggest macroeconomic challenges is to bring down fiscal deficits. While

the Ministry of Finance expects the fiscal deficit to reach 3% of GDP in 2016 and 3.2% of

GDP in 2017, a 4% of GDP deficit would be unsustainable, according to the IMF. While it

expects VAT to remain unchanged, the mineral extraction tax (MET) is seeing a rise on

reduced export duties for oil. At the same time, 2017 spending needs to be fixed at 2016

nominal levels, which could be challenging.

One channel to finance the fiscal deficit is privatisation. Yet, privatisation of energy

companies looks like transferring money from one state pocket to another, given that the

buyers have historically been other public or semi-public entities. The IMF sees about a

USD10/bl stronger oil price than the Russian authorities are using in their base-case

scenarios for 2016-17; hence, there may be some upside for public finances.

Sanctions. The worst of the short-term impact is probably over but the long-term impact

may still be lower FDI (foreign direct investment) levels than before 2014, limiting the

important transfer of international know-how. Equally, capital outflows are much lower.

Significant deleveraging (caused by financial sector sanctions) is improving economic

stability though.

The rouble. A strong RUB may be more a concern for the Ministry of Finance than the

central bank. The latter is probably more amenable to a strong RUB, as this would help

bring down inflation pressures.

Banking sector profitability is improving. NPLs have gone up but not that rapidly.

Lending is not doing well but improvements are visible. While the top 50 banks are in good

shape, the top 50-100 banks are not doing well. The top 100-600 banks are fine.

The IMF revises up its Russia’s GDP

outlook…



...while the fiscal side is a concern



Current account surplus prevails...



...while public debt stays low




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Turkey – (geo)politics make for uncertain economic outlook

The country saw healthy growth before the coup attempt in July. Real GDP growth

had been particularly strong in early 2016 due to fiscal expansion, as minimum wages were

raised by almost 6% in real terms, stimulating private consumption. Yet, due to Russia’s

sanctions and shrinking tourism, high corporate debt and falling investments, economic

growth began to slow in the spring. At the same time, increased wages and the strong lira

challenged external competitiveness. The IMF expects real GDP growth to be 3.3% in

2016, slowing to 3% next year. Upside risks for GDP projections come from the renewed

economic collaboration with Russia.

The coup attempt was a significant but temporary shock to the markets. However,

Turkish stocks and the lira recovered faster than expected and the lira has remained

relatively resilient due to domestic depositors selling USD. Yet, on most metrics, the lira is

considered to be overvalued. Political rearrangements in the public sector have prompted

concerns for medium-term budget plans.

The central bank’s inflation target has not been reached for a long time. This questions

whether the CPI target of 5% y/y is de facto the target of the central bank or whether it is a

bit higher. As a result, one could maybe expect CPI inflation below 7% y/y to trigger a

benchmark repo rate cut.

There are risks to the Turkish economy from a hawkish Fed due to large refinancing

needs. A negative loop exists, as corporate dollar debt increases significantly when the lira

depreciates: this could increase non-payment of debt to banks, with bank balances

weakening, triggering further capital account outflows and exchange rate weakening. The

current account non-oil balance has not improved much, as the current account has so far

been quite insensitive to the movement in real exchange rates.

Turkey’s economy is slowing down…



…while a fiscal deficit prevails



Current account deficit stays wide…



…while public debt remains relatively

low




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Brazil – IMF holds new administration in high regard

The IMF appears to hold the new Brazilian administration in high regard. The new

government seems more transparent than the previous one; for example, it agreed to publish

the concluding statement of the recent IMF Article IV mission. The new administration

seems to comprise a very good team with serious-minded people that come from prominent

think tanks. This has hastened the preparation of difficult reform proposals, such as social

security reforms and the spending cap. The government has also made a concerted effort to

explain the need for reforms to parliamentarians to increase the chance of getting reforms

through.

The IMF has turned moderately more optimistic on Brazilian economic growth. The

fund now sees the economy contracting by 3.3% this year, while rebounding by 0.5% next

year. This forecast of a recovery next year is somewhat more subdued than our (and other

houses) forecast of 1.4%, although the IMF acknowledged that there are potential upside

risks to its forecast. The government sees economic growth at 1.6% next year.

The rebound in the economy hinges on implementation of reforms, which will boost

confidence and allow interest rates to come down. For now, the IMF is giving the new

government the benefit of the doubt. Looking at the period ahead, the IMF sees only a

modest pickup in growth, as deleveraging of household and corporates will weigh on

growth. The IMF noted that net debt to equity is high by historical standards. Bankruptcy

rates have crept up to very high levels, with larger firms now also closing in addition to

small companies. This trend is set to weigh on investment. Unemployment is lagging so

private consumption remains subdued also. The IMF sees a longer term growth rate of 2%

for the Brazilian economy.

Structural fiscal reforms are among the most important measures. The IMF sees a very

good chance that the government will get the expenditure cap through parliament. A first

step was taken recently as the chairman of the budget committee presented a proposal that

was very close to the original proposal with relatively minor modifications introduced.

Despite the implementation of reforms, the debt dynamics are still quite challenging for

Brazil and warrant caution.

The government has been working on a proposal for social security reforms for

several months now. It is trying to co-operate with key stakeholders to build consensus

for the reforms. The reform has been delayed but may be sent to Congress later this month

or in November.

On monetary policy, the IMF sees virtue in the Brazilian central bank’s approach to

wait for progress with fiscal reforms before moving ahead with rate cuts. The central

bank has been asking for fiscal reforms for a long time. Furthermore, it is critical to see a

faster reduction in inflation expectations, which is more likely if the reforms are approved.

The IMF finds the Brazilian real slightly overvalued at current levels. As explained in

the IMF’s 2016 External Sector Report, following the weakening of the exchange rate in

2015, the BRL was more or less in line with fundamentals but with the recent strengthening

and with prospects for some widening of the current account deficit in the period ahead, it

finds it to be stronger than warranted by fundamentals and policies.

The Brazilian economy is rebounding,

while inflation is being brought under

control



Though the government is facing a

mounting fiscal challenge…



...while external imbalances have been

reduced…



...while public debt keeps rising.




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Mexico – sound macroeconomic policies amid US election risks

In theory, Mexico should be the darling among emerging market investors. It has

strong policy institutions, super-prudent monetary and fiscal policies and a young and

dynamic population. In its latest WEO projections, the IMF expects the Mexican economy

to grow 2.1% in 2016, picking up to 2.3% next year, due to weak investment sentiment and

fiscal consolidation planned for next year.

On fiscal policies, the IMF viewed the newly-presented 2017 budget as fairly tight.

The budget envisages a 2% of GDP cut in spending, while revenues are unchanged. The

cut in spending is split equally between Petróleos Mexicanos (PEMEX) and public

investment. There are no concerns about debt sustainability.

Monetary policy was also seen as cautious. Indeed, the IMF found it may be a bit too

tight. The IMF did not see many first-round effects of the weakening of the peso and

second-round effects were not present. However, given the country’s history of currency

crisis, the central bank wants to be on the safe side ahead of the US elections and possible

Fed tightening. As a result, the central bank does not have to raise rates even if the Federal

Reserve raises rates in December.

A possible US tariff increase on Mexican exports following the US election could have

a significant impact on the Mexican economy. Around 80% of Mexico’s exports go the

US. However, not only would Mexican trade slump, if the US tariff rates were increased to

say 35%, portfolio investment and FDI are also likely to be hit given uncertain prospects

for the Mexican economy. As a result, real GDP growth could fall significantly compared

with current projections. However, a confiscation of remittances may not be a realistic

option.

However, a sharp increase in US tariffs would probably be followed by legal action

from the Mexican side. A sharp rise in tariffs to, for example, 35% on selected Mexican

goods would not conform to WTO (World Trade Organisation) rules. A more modest

increase in tariffs by 3.5% would not necessarily breach WTO rules.

The peso is probably about 10% undervalued at current policies. However, in case of

a significant hike in tariffs, the equilibrium exchange rate could weaken by a sizeable

margin compared with the current value.

Economic growth has held up well and

inflation pressures are contained



But improvement in macroeconomic

balances could have been more

ambitious…



…hence public debt should not fall a lot




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Sub-Saharan Africa – a two-speed continent

The IMF sees a two-speed Africa at the moment. It has significant concerns about the

big commodity-producing countries: Nigeria, Angola and South Africa. These countries

are struggling and dragging down the overall growth rate for the continent – estimated at

1.5%, which is the lowest in 20 years and negative in per capita terms. Nigeria has fallen

into recession. Given the ‘low for longer’ outlook for commodity prices, there is a need for

fundamental adjustment, which some of the countries are finding difficult to adopt, notably

Nigeria, where measures have been second-best options.

On the other hand, in oil-importing countries, economic growth continues to remain

very strong. The IMF expects real GDP growth to exceed 5% in many countries in 2017-

18 due to expansion of public investment, regional integration and population growth.

Notably, eastern Africa countries such as Kenya, Tanzania, Rwanda and Uganda are among

Africa’s fastest growing countries. The flipside to public investments is, however, a rise in

fiscal deficits in many countries. However, public debt remains at sustainable levels in most

countries due mainly to the significant debt reduction undertaken in the context of the

heavily-indebted poor country (HIPC) debt reduction initiative but some countries, such as

Mozambique, are already seeing a large debt burden.

Are the relatively high growth rates sustainable? According to the IMF, much will

depend on how much of the investment goes to productive projects. Here, there are signs

that a significant part of investment goes to decent infrastructure. Furthermore, regional

integration in many regions (notably in eastern Africa) is raising potential growth in the

member countries. The most important reform area is to proceed with improvement in the

‘doing business’ environment.

One of the biggest uncertainties is the governance situation. The IMF pointed to the

Transparency International’s indicators presenting a mixed picture. However, IMF staff also

stressed that there was much more awareness about the outside world and the need to be

transparent, especially in the countries that relied on international capital markets. Rwanda

has improved its indicators significantly, notably with respect to corruption and there are signs

that other African countries are looking to these best practices.

In South Africa, the authorities are facing a combination of weak growth and fiscal

problems. There is a need to focus on product and labour market reforms. FDI and

productivity are too low, while wages are generally too high. If reforms are adopted, this

may potentially raise growth from around 1.5% to about 2.0%. However, the ability and

willingness to implement the needed reforms is highly uncertain – a survey of political

uncertainty is at its highest since 1980, i.e. before the fall of apartheid. A possible rating

downgrade would be negative but not the end of the world. However, a negative scenario

would certainly entail a downgrade, combined with uncertainty about the policy direction

in South Africa and a Fed hike in December.

Nigeria has been slow to adjust to lower commodity prices but is starting to take

action. The toll on the Nigerian economy from the oil price shock has been compounded

by an inability to diversify the economy and violence around the production fields. The

Nigerian economy is now in recession with real GDP projected to fall by 1.7% in 2016.

The Nigerian authorities need to implement a three-pronged strategy: fiscal adjustment

(raising non-oil revenues, reducing current expenditures while allocating more to public

investments), more FX flexibility (the FX rate is still not at the level needed with the black

market rate premium at 35%) and structural reforms (boosting infrastructure and

strengthening housing).

The fall in commodity prices has

created challenges in sub-Saharan

Africa



Government revenues are falling



Despite higher fiscal deficits, public

debt remains relatively low in sub-

Saharan Africa




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Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’).

The authors of the research report are Jakob Ekholdt Christensen, Chief Analyst, and Vladimir Miklashevsky,

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