Global Themes: Trade Is The 'Sick Man' Of Global Demand

  • Global trade growth has collapsed to the low single-digits, compared to rates between 10-30% leading up to the crisis and during the post-crisis rebound. We see the two driving factors behind this worrying decline as resistance to global rebalancing and the creeping tide of protectionism.

  • The Ukraine situation, which has led to speculation of potential economic and/or selected trade sanctions on Russia, presents near-term risks to global trade.

  • Although China's exports have held up well, Asia's other export powerhouses have fared poorly of late. As the year progresses, Chinese export shipments are likely to join in the regional contraction. Falling commodity prices are putting pressure on exports in Africa and Latin America.

Global Outlook: Having been the driving force behind global growth and the rapid industrialisation of emerging markets in the 2000s, international trade remains stuck in a low gear following the financial crisis. As the chart below shows, growth in global exports has collapsed to the low single digits having expanded at rates between 10-30% leading up to the crisis and during the post-crisis rebound. This dynamic is not just confined to developed market underperformance, but also reflects a sharp slowdown in emerging market trade growth. This is problematic for both given that heavily indebted developed states have been relying on a recovery in exports to mitigate weak domestic demand, while emerging markets remain largely dependent on old-school mercantile growth models given the lack of structural economic reforms.

Broadly speaking we believe that there are two dynamics which underpin the current sluggishness in global trade: resistance to global rebalancing and the creeping tide of protectionism. In the case of the former we have long warned about the difficulties of rebalancing the global economy ( see "Global Rebalancing: A Conflict Ridden Path", October 2012) given the resistance to change among surplus states and the lack of coordinated multilateral policymaking. Despite hinting at domestic structural reforms, China and Germany have so far failed to materially transition away from entrenched mercantile growth models. With producer prices falling in both of these economies as exporters struggle to maintain orders amid weak external demand, the rebalancing process is being further drawn out. This risks creating a negative feedback loop if producers in debtor states also cut prices in a bid to maintain foreign market share. Given that the global balance of payments is a closed-system, a situation in which both debtor and surplus states try to raise exports is ultimately self-defeating and poses a major impediment to international trade.

A DM And EM Story
Global - Goods Exports, % chg y-o-y
  • Global trade growth has collapsed to the low single-digits, compared to rates between 10-30% leading up to the crisis and during the post-crisis rebound. We see the two driving factors behind this worrying decline as resistance to global rebalancing and the creeping tide of protectionism.

  • The Ukraine situation, which has led to speculation of potential economic and/or selected trade sanctions on Russia, presents near-term risks to global trade.

  • Although China's exports have held up well, Asia's other export powerhouses have fared poorly of late. As the year progresses, Chinese export shipments are likely to join in the regional contraction. Falling commodity prices are putting pressure on exports in Africa and Latin America.

Global Outlook: Having been the driving force behind global growth and the rapid industrialisation of emerging markets in the 2000s, international trade remains stuck in a low gear following the financial crisis. As the chart below shows, growth in global exports has collapsed to the low single digits having expanded at rates between 10-30% leading up to the crisis and during the post-crisis rebound. This dynamic is not just confined to developed market underperformance, but also reflects a sharp slowdown in emerging market trade growth. This is problematic for both given that heavily indebted developed states have been relying on a recovery in exports to mitigate weak domestic demand, while emerging markets remain largely dependent on old-school mercantile growth models given the lack of structural economic reforms.

A DM And EM Story
Global - Goods Exports, % chg y-o-y

Broadly speaking we believe that there are two dynamics which underpin the current sluggishness in global trade: resistance to global rebalancing and the creeping tide of protectionism. In the case of the former we have long warned about the difficulties of rebalancing the global economy ( see "Global Rebalancing: A Conflict Ridden Path", October 2012) given the resistance to change among surplus states and the lack of coordinated multilateral policymaking. Despite hinting at domestic structural reforms, China and Germany have so far failed to materially transition away from entrenched mercantile growth models. With producer prices falling in both of these economies as exporters struggle to maintain orders amid weak external demand, the rebalancing process is being further drawn out. This risks creating a negative feedback loop if producers in debtor states also cut prices in a bid to maintain foreign market share. Given that the global balance of payments is a closed-system, a situation in which both debtor and surplus states try to raise exports is ultimately self-defeating and poses a major impediment to international trade.

Trade No Longer Driving Global Growth
Global - GDP & Exports, % chg y-o-y

This leads on to our second explanation for the slowdown in trade flows: trade protectionism. Although 159 countries have signed up to the provisions of the World Trade Organisation, which is dedicated to liberalising trade, protectionist barriers continue to pop up. Unlike tariffs and quotas which are straight forward to identify, more subtle forms of protectionism such as strict local content requirements, or draconian environmental or health and safety standards can make it prohibitively expensive for firms to sell in some markets. Given the opaqueness of such measures, it is difficult to quantify the scale of implicit protectionism, or the economic cost, with much of the evidence being anecdotal. However, the emergence of these threats to global trade nonetheless chimes with the reluctance among some states to drop protectionist measures and the associated rise in international trade tensions in recent years. Among the biggest near-term policy risks stems from the situation in Ukraine, as the Western powers contemplate economic and/or limited trade sanctions on Russia.

Europe - Already Weak, But Ukraine Crisis Makes Things Worse: Even before events in Ukraine took a turn for the worse we had expected currency weakness to dampen import demand in key emerging European economies. However, the regional trade picture has become much bleaker following Russia's decision to increase its military presence in Crimea, with a negotiated resolution looking unlikely at this stage, and the threat of trade restrictions already pushing up commodity prices as investors anticipate supply tightness. Apart from outright trade sanctions, another potential scenario which would hurt regional trade is the imposition of economic sanctions by Western powers on Russia. Discerning the extent and type of potential sanctions on Russia is very hard at this stage, since any action would hurt Europe's economic recovery via supply shortages and higher prices. For instance, Germany and Italy are both heavily dependent on Russian gas imports (see chart), and German gas prices have already spiked on the back of recent events. Russia is a large wheat exporter, as is Ukraine, and potential threat to supply has seen wheat, corn and by contagion soy prices rise in recent trading. Coal is another potential target for Western sanctions, particularly since the direct impact on regional trade and growth would likely be less severe.

Germany Heavily Reliant On Russian Gas
Russia - Largest Gas Exports Markets in 2012 (excluding LNG), bcm

That said, since trade sanctions would be painful for Europe, they are likely to be pursued only after diplomatic channels have been exhausted, and we are some way from that at present. Another preferred course of action may be targeted seizures of Russian overseas assets, since this could increase domestic political pressure on Putin without severely harming Western Europe's economic recovery. Yet even if trade sanctions are not implemented we are likely to see some supply restrictions, since Ukraine remains a key transit point for Russian gas exports to Europe, and Ukrainian wheat exports may be blocked by the Russian navy in the Black Sea. Combined with the currency impact of recent events (the Russian rouble is currently trading to close to record lows against the US dollar), in our view the impact on regional trade is clearly negative.

Asia - Weak Export Picture But Regional Surpluses Still Intact: Asian exports are struggling so far in 2014, with the export powerhouses of Taiwan, Korea, Hong Kong and Singapore all posting annual contractions in January. China is the only major exporter in the region that is bucking the trend, with exports in January jumping 10.6% y-o-y, although we question the reliability of this data given the distortions caused by hot money inflows from Hong Kong masquerading as exports. The rapid increase in intra-regional trade over recent years suggests that the shipments actually leaving Asia are likely to be contracting at an even faster pace. As the year progresses, Chinese export shipments are likely to join in the regional contraction, as the impact of the rapidly strengthening yuan (in real effective terms) begins to weigh on competitiveness.

Exports Going Nowhere
Asia - Export Growth, % chg y-o-y

Looking at current account pictures across the region, we have begun to see a pick-up in the regional surplus, which had been declining over recent years. Domestic imports across the region are contracting at a faster pace in most countries, putting upside pressure on trade balances. With a simple average current account surplus for the region of 3.9% of GDP, we remain medium-term bulls on Asian FX. The recent bout of weakness across regional currencies was driven largely by portfolio outflows, which should return over the coming months. The one exception, in our view, is China, where we are increasingly concerned that the yuan could experience a sharp decline. Indeed, China's once-formidable current account continues to dwindle, and the domestic economic picture is beginning to sour, which, combined, will likely see widespread expectations of further currency strength reverse.

Latin America - China Slowdown A Game Changer For Regional Trade: While trade in Latin America posted a notable recovery following the global financial crisis, with the goods trade accounts of most major economies remaining in surplus as high commodity prices bolstered the region's major metals producers, we believe that slowing growth in China and lower metals prices will have a sustained impact on Latin American trade balances in the coming years. Indeed, we estimate that 2013 saw the goods trade surpluses of several major LatAm economies narrow sharply, especially Argentina and Brazil, and we foresee little upside for the latter, in particular, in the coming years.

Surpluses Unlikely To Return To Recent Highs
Latin America - Selected Major Economies' Goods Trade Balances, US$bn

While Brazil posted a modest goods trade surplus of US$2.5bn in 2013, we expect that moderate export growth in the next few years, combined with a pick-up in imports, will see the trade account flip into deficit in 2014 for the first time in over a decade. Indeed, the real appreciation of the Brazilian real over the last decade, as well as significant labour and tax costs have eroded the competitiveness of Brazilian manufactured goods, while weakening Chinese demand for industrial metals will continue to dampen commodity exports. These dynamics, in turn, will weigh heavily on the overall balance of goods trade in major Latin American economies, keeping the surplus well below the levels seen in the past few years.

Sub-Saharan Africa - Subdued Exports And Robust Imports Create Vulnerabilities: Across Sub-Saharan Africa (SSA), current accounts are being strained by the combination of depressed export earnings and resilient import demand. We expect this to remain the case over the medium term, meaning that the current accounts will continue to be a key structural macroeconomic weakness for the vast majority of countries in the region. Focusing first on exports, subdued global commodity prices stemming largely from the slowdown in China are weighing on export revenues. Our Commodities team forecasts that prices will remain relatively low for copper, gold, iron ore and oil over the next 18 months or so - notwithstanding the current spike in gold and oil prices which has been triggered by the crisis in Ukraine. The overriding trend for subdued prices will be particularly damaging in instances where cutbacks in production are being triggered. For example, in Ghana's gold mining sector, several companies are considering the closure of mines and there has been a wave of job losses. Similarly, divestment has taken place in South Africa's gold mining sector amid lower prices, although a host of other factors (particularly tense industrial relations) have also come into play. That said, the general state of play across the region is that lower commodity prices are being weathered and production plans remain in place.

Resilient Imports Weigh On Trade Balance
South Africa - Current Account Balance And Components, ZARbn

Middle East & North Africa - Israel To Benefit Most From Pickup In Europe: The gradual pickup in economic activity in Europe will have a nuanced, though generally positive, impact on the Middle East and North Africa's export growth over 2014, with Israel standing out as the key beneficiary. Europe (particularly Germany, France and the UK) is a major export destination for Israel, Morocco, Tunisia and Egypt and the lack of growth in exports over the past few years has been the significant laggard out of the GDP growth components. However, given the uneven pickup in growth in Europe, issues of competitiveness and the balance of exports, we expect significant divergence across the MENA region. We expect the uptick in growth across Europe will be uneven, with notable difference between the major European export partners of the Middle East. On a relative level, we expect Germany and the UK to see the strongest rates of growth, whilst France and Italy remain laggards. In this regard, Israel and Egypt stand to benefit most given their relative reliance on Germany and the UK, in contrast Morocco and Tunisia's exports will be restricted by their focus on France and Italy which account for around 65% of their exports to Europe.

Europe Uptick To Bolster MENA's Exports
Middle East - Destination Of Exports (%, 2012)

Competitiveness will also benefit Israel and Egypt, to the detriment of Tunisia and Morocco. The recent appreciation of the British pound and the euro has had little impact on the latter two given their peg to a basket with around a 70% weighting of the euro. In contrast, Egypt and Israel have benefitted from competitiveness gains as their currencies have lost value relatively compared with the euro and pound over the last few months. Finally, the composition of exports will play a key role in determining export growth. For Germany and the UK, we expect exports tied to final consumption to benefit most. The impact of this is fairly even in the Middle East given that textiles account for around 20-30% of each country's exports to Europe. In addition, for Israel, the uptick in consumer sentiment in Europe as revealed by a host of indicators around the turn of the year bode well for diamonds, which account for 17% of Israel's exports to the continent.

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Sector: Country Risk
Geography: Global, Ukraine, Russia
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