Suparna Goswami Bhattacharya

August 3, 2016: Of late, China has been less in the news for its ‘slowdown’. Economic activity in the country has stabilised in recent months, mostly on the back of the property market rally and strong infrastructure investments.

But, there is another challenge before the economy — slowing growth in labour productivity. The country is moving away from manufacturing towards services, a phenomenon which is called deindustrialisation. Though most economies in the world go through this phase, in China’s case it has been ‘premature’.

Deindustrialisation is a process of social and economic change caused by the removal or reduction of industrial capacity or activity in a country or region, especially heavy industry or manufacturing industry. It implies that productivity growth through rural-urban labour migration has started to slow, clouding the medium/long-term growth prospects if this trend is entrenched.

Qu Hongbin, chief China economist, HSBC, says both economic theory and empirical evidence suggest that premature deindustrialisation in developing countries can be damaging. “It blocks the main channel of productivity growth, and therefore reduces the economy’s potential growth rate and its prospects of catching up with more advanced economies. Given that China’s GDP per capita is only 14% that of the US, we believe it is way too early to shift towards services-led growth,” says Hongbin.

Around 2008-09, the industrial sector was affected by weakening external demand, which forced China to follow a different path.

Glenn Maguire, chief economist, South Asia, ASEAN and Pacific, ANZ, says, “The model was to shift economic growth away from reliance on exports and investment towards domestic consumption. Aligned with this, the government aimed to accelerate the growth of China’s services industries whilst targeting a reduction in industries suffering from overcapacity or inefficiencies – largely heavy industry associated with infrastructure and industrial production.”

From 2013, the services sector replaced the industrial sector as the biggest contributor to

China’s economic growth. According to data by HSBC, in Q2 2016, the services sector accounted for 51.9% of overall real GDP growth in China, compared with 40.7% for the industrial sector.

The economy obviously saw the benefits of the move. To begin with, the fast expansion in the services sector helped prevent GDP growth from sliding too fast. Between 2012 and 2015, the services sector has maintained robust growth of around 8.1% y-o-y, while output growth in the industrial sector decelerated from 8.2% y-o-y to 6.0%. Therefore, across the same time period, overall GDP growth fell by less than 1ppt (from 7.7% y-o-y to 6.9%), despite the sharp decline in the industrial sector.

According to China economist Chang Liu who works independently, the services sector has been able to maintain employment levels. “Despite slower GDP growth due to the underperforming industrial sector, China maintained healthy growth in jobs at 13m per year, all thanks to the services industry which is more labour intensive than manufacturing,” says Liu.

Though in the short run such a move did prevent a hard landing for China, from a long-term perspective a premature shift to services-sector led growth implies a huge efficiency loss. Jing Li, economist, HSBC, says, “The biggest source of productivity growth comes from the transition of labour from the agricultural sector to non-farm sectors. Therefore, the sector distribution of those migrant workers determines whether the economy is growing in the most efficient manner.” To this extent, this reshuffling towards the service industry means that a less productive sector is replacing the manufacturing sector as the main absorber of rural migrant workers.

An HSBC report states that between 2012 and 2015, the total number of migrant workers in the manufacturing sector declined by nearly seven million, compared with an increase of five million in the three biggest services sectors — wholesale and retail, residential services, transportation and logistics. Based on 2015 statistics, each worker in the manufacturing sector generated RMB45,000 more output than their counterpart in the three biggest services sectors.

Additionally, manufacturing industry is always on tenterhooks since it has to constantly upgrade itself in order to stay competitive and relevant. This improves the overall health of an economy — something very essential for a growing country.

“China still enjoys a high savings rate of nearly 50% of GDP. It is crucial that China does not pursue rebalancing towards consumption and thus lose the window of opportunity to catch up with more advanced economies. To avoid the middle-income trap, China needs to make more efficient investments and continue on the industrialisation path – this will be a challenge,” concludes Hongbin.

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Suparna Goswami Bhattacharya

July 28, 2016: Almost a month after the UK decided to exit the European Union, economists around the globe have come out with data suggesting that the referendum has had a mixed impact on the global economy with certain areas getting affected more than the others.

IHS Markit, a global insight company, in its report stated that Brexit will cut global economic growth by 0.1 per cent in 2016 and 0.4 per cent in 2017. Further, it will reduce growth in some of the world’s largest economies — UK growth to drop from 2.4 per cent to 0.2 per cent and Eurozone to drop to 1.1 per cent in 2017.

In the UK, it is expected to cause major economic and political uncertainty and will weigh down on business and household confidence and behaviour, thus dampening corporate investment, employment, and consumer spending.

Jaspreet Sehmi, senior economist, Dun & Bradstreet, feels that the UK economy is passing through the eye of a storm. With a new government at the helm trying to navigate the UK economy through previously unexplored territory, the journey ahead remains long and uncertain. “We expect the UK to enter a technical recession at some point between the second half of this year and the first half of 2017. Businesses are facing increased uncertainty, and anecdotal evidence suggests that firms are already scaling back investment and hiring plans,” says Sehmi.

In the Eurozone, the overall impact is likely to be negative, as any reduction in size of a single market makes it less valuable for those remaining in it. According to IHS Markit, the UK’s decision to leave will increase political instability and economic uncertainty in the Eurozone, weighing down on business and consumer confidence and activity. Additionally, Brexit has given momentum to other euro-sceptic political parties across the EU, some of whom also want a referendum on EU membership.

Tom Elliot, international investment strategist, deVere Group, says, “This makes it harder for governments to agree to a closer fiscal and political union which many economists believe is the call of the hour. This is illustrated by the difficulty in establishing a euro zone banking union.” Brexit is also likely to distract EU decision makers from core focus areas. The European Union should now be focusing on issues like the banking crisis (with Italian banks the current problem), migration, structural impediments to economic growth such as two-tier labour markets. These problems hinder EU’s ability to exert influence on the global stage, whether economically or politically, adds Elliot.

The Eurozone will also face a loss in competitiveness in manufacturing on the back of weaker GBP and increased uncertainty, potentially delaying investment decisions. “While sterling has remained weak, the swift formation of a new UK government has reduced volatility in financial markets, which should contain the negative impact on confidence going forward,” says Peter Vanden Hout, chief economist, Eurozone, ING.

The extent of the impact on Asia will largely depend on the outcome of the negotiations between EU and the UK. The principal transmission mechanisms of the Brexit shock to the region will come from trade, the financial sector and business confidence. Given the relatively small ties between the region and the UK, the shockwaves will reach Asia mainly via secondary channels.

Ricard Torne, head of economic research, FocusEconomics, says, “While shipments to the UK from Asia ex-Japan are relatively small (around 2.5%), those from the region to the Euro area are much larger and represent around 11% of the total exports. Therefore, the expected slowdowns in the Euro area following the Brexit vote, particularly in core countries such as Germany, will likely hurt Asia’s already-battered external sector.” Nevertheless, the impact on the region will be uneven. The countries which are more reliant on domestic demand, such as India, Indonesia and The Philippines, will weather the storm better than open economies like Korea and Taiwan. Financial hubs Hong Kong and Singapore will also feel the brunt due to heightened volatility in the financial markets, adds Torne.

Brexit will not impact US real GDP growth much in 2016, which is still forecast to be 1.9 per cent. “A relatively small proportion of US GDP growth comes from overseas trade, and the relative strength of the euro against the dollar year-to-date will offer American exporters some protection from any post-Brexit reduction in European investment spending and tourism,” says Elliot.

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Suparna Goswami Bhattacharya

May 17, 2016

How is the financial sector doing in the context of the current political and economic instability in Ukraine?

The economic situation in Ukraine is determined by several factors. First, due to the ongoing military operations, no new investments are coming to Ukraine. Second, the structure of our foreign economic relations is completely changing. In the past year-and-a-half, economic relations with Russia and the CIS countries collapsed. Developing these relationships in other places, like Europe, America, China or India, will take time. These factors combined with the downturn in global prices for chemistry and metallurgy products, which constituted a significant portion of Ukraine’s exports. The agriculture sector has been doing more or less okay. Sufficiently large businesses that operate in this sector are connected with industrial land processing. The IT sector is another industry that is actively developing in Ukraine.

With regards to the banking industry, the major risk factor is not a decrease in business volume. In fact, banks experienced an increased in volume of business due to the natural increase in the customer base from the regulatory process of removing unsafe banks. For example, with PrivatBank, the volume of transactions increased by 20% over the course of the year.

Instead, the risk factor is the fall in profitability; the lion’s share of banks operate in Ukraine with significant losses. On the one hand, the profitability of banking business fell because corporate customers were under pressure due to the economic situation. Although, despite the falling profitability of the corporate portfolio, the quality of the retail portfolio improved along with that portfolio’s profitability.

On the other hand, today the value of transactions processed by banks in Ukraine is comparable to the size of the commission which is taken for such a transaction in the West. While the number of transactions has not diminished, people have become poorer. In this situation, the mass processing of small payments is on the verge of profitability. But use of paper is not cost effective. All these retail payments should be electronic and switch to mobile devices. This is what we are doing today at PrivatBank.

As a result, PrivatBank is one of the few Ukrainian banks that operates with a profit. Due to this, the number of our customers grows because not all banks operating in the country see their future in retail. Retail is costly and if the bank did not invest in this sector earlier, it is unlikely to build the infrastructure of branches, ATMs and staff today. The process of doing so is very expensive.

How is PrivatBank going to overcome this crisis?

During the political and economic turmoil, the bank has also faced attacks from terrorist forces on our physical locations, major attacks on our Internet facilities, including the server. The military action in the country has made it difficult to plan the usual activities of the bank. In spite of the turmoil, it is important for us to continue with our technology development. Advanced technology allows us to reduce banking costs, thus providing more support to customers.

Today, PrivatBank serves 1.6 million to 2.5 million unique clients daily. Every day, many people reach us through smartphones, our ATMs, branch locations and self-service terminals. The bank was able to significantly reduce the cost of operations and increase their number by switching clients to remote service or self-service. Today, we can confidently say that PrivatBank is a technology company. Not only are we financiers, but we are technologists to improve our customers’ financial experiences.

We primarily focus on retail lending to entrepreneurs and micro-credit for the development of self-employment. This business segment does not require large capital expenditure. We have accumulated a large amount of data in order to provide these loans. Additionally, the cost of borrowing for small business can be reduced through new lending formats. In April 2016, we launched the first CUBE service in Ukraine, which many have called ‘the Ukrainian Kickstarter’. The service allows entrepreneurs to represent their businesses and its development projects, and receive direct investment from private clients. These are small amounts of loans —$ 15,000 at the highest end — but it’s an important tool for growing the real economy.

PrivatBank acts as an operator of the CUBE platform: we score loan applications and help investors hedge their investments so that this method of investment is safe. According to our estimates, these programs can now give Ukraine a million job positions while investing about 20 billion hryvnias into the real economy.

The bank has implemented a lot of ideas related to improving the efficiency of interaction with customers, not only at the stage of implementation of payments but also while buying anything. This includes migrating web-based applications to smartphones, and not only connecting banking services to these applications but also services that help customers solve their tasks. In addition, we want to teach everyone electronic banking. The screen on the tablet in our branch is the same screen you see on your computer and smartphone. Once the customer sees and understands how to carry out the transaction, the next time he will not need to come to the branch. With this infrastructure it only becomes necessary for the individual to come to bank for the first time. It is a worldwide practice to not allow remote opening of accounts, and this is about financial identification. Once the financial identification is carried out, we just have to make sure that you are able to obtain services through smartphone.

What is the range of new services and products offered to clients?

Over the years, PrivatBank has launched a variety of new services and products that directly change the banking landscape, not only in Ukraine, but also worldwide. Today, our technological achievements have allowed us to seriously change the mechanism for the management of our internal business processes, make it digital and rapidly expand the transformation of business processes using the Corezoid cloud operating system. By the way, today we openly offer to use the Corezoid system for our colleagues around the globe. Corezoid is a platform, on the basis of which Western Union, in cooperation with PrivatBank, launched money transfers in Ukraine. Once created, processes can now be easily copied throughout the world, adding necessary local settings. For example, it may take our bank from a few days to a few weeks to introduce new services from concept to practical implementation — a truly rapid pace for the banking industry.

We believe that today banks should give the customer not only those services which have been typically provided by banks since the advent of modern banking, but also take a broader look at the processes. Instead of relying on successful competitors to innovate, we prefer to go into a creative mode and develop ideas on our own. For example, today in our mobile Privat24 bank, in addition to traditional payments, there are opportunities to purchase tickets, clothes, food, and order taxis.

Our offices now use iPads instead of PCs. The reasoning behind this is not only better quality, but also the ability to easily learn how to do the same operations using the tablets and mobile phone you already own without leaving the comfort of your home.

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Suparna Goswami Bhattacharya

February 2, 2016: Europe had been in the news in 2015, not every time for the right reasons though. Grexit, the Volkswagen scandal, migration crisis, Paris attacks were some of the low points which made economists and investors wonder whether or not to pin their hopes on this continent for 2016.

Though shakiness in the world economy, oil price slump, China’s slow growth did contribute to the sombre mood, not much improvement in the scenario is expected.

Angela Bouzanis, senior economist at FocusEconomics, believes that Europe’s recovery will continue in 2016. “We see Eurozone economy expanding 1.6%, slightly above what we predicted in 2015 (1.5%), amid solid domestic demand and continuation of an accommodative monetary policy,” she says.

Dan Kemp, Chief Investment Officer, EMEA, Morningstar, an investment research and management firm, says that while looking at Europe one needs to separate economic outlook from that of capital markets. “In economic terms, there is clear strength in business and consumer survey data and increased support from domestic demand. These indicate underlying trends remain robust,” says Kemp. However, in capital market terms, much of the good economic news appears to have been already priced into European equities and, consequently, most equity markets look expensive. “The risks appear to be on downside. Opportunities stem mainly from the structure of their capital markets, like their exposure to energy companies,” he said.

Though energy companies have been a drag on returns, the fact is that they are now materially underpriced and, therefore, represent an attractive long-term investment opportunity. “As we create our expected returns at a country and regional level from the bottom up, the value we perceive in these stocks is having a positive impact on our expected returns for those countries with significant exposure to energy companies,” he says.

However, a number of challenges remain, namely the political landscape, persistent high unemployment and very low inflation expectations. In addition, while a weak euro is conducive to export growth, external conditions are not. The emerging market slowdown, particularly in China, and overall pattern of slowing global trade will weigh on growth prospects this year.

Satyajit Das, a former banker and author of Age of Stagnation (published as A Banquet of Consequences in UK, Europe, Australia and NZ), says, “One has to understand that Europe’s tentative recovery was driven by negative short term rates, massive QE, a weaker euro (driven in part by these policies) and low oil prices. But the continent has a deteriorating outlook.”

For instance, German exports to emerging markets are slowing. Exports in August 2015 for Germany were 5.2 per cent lower than July, the sharpest monthly fall since the financial crisis, according to the national statistics office. Germany, which happens to be Europe’s biggest exporter, sends 6.5% of its exports to China, which has been experiencing a slowdown.

“Additionally, the Volkswagen emissions scandal has brought into question much vaunted European technical prowess. European debt problems remain unresolved. In the aftermath of the attacks in Paris, the French government has announced that they will not abide by deficit and debt limits. Italy refuses to bring public finances under control, despite a worsening debt-to-GDP ratio,” says Das.

As far as Greece is concerned, it is likely to be in spotlight this year as well. “Our panel sees Greece’s economy worsening this year, as tough economic reforms and austerity measures are expected to dampen private consumption and stifle the recovery. High unemployment, tax increases and pension reductions will likely push the economy to a 0.7% fall this year,” says Bouzanis

To be honest, Greece’s situation remains in flux. While the current government has been largely compliant with last summer’s bailout agreement, a number of key and controversial reforms still need to be passed. “The government holds a slim three-seat majority and political stability (or willingness to comply with creditor demands) is far from guaranteed. In addition, in the long-run, there is a large risk that this bailout could suffer from the same obstacles as its predecessor: foot-dragging on reforms, poorer than expected economic growth or political upheavals and the question of request of debt relief is yet to be answered,” adds Bouzanis.

Das echoes these views. “The government will find it difficult to meet bailout conditions raising the issue of default, Grexit or both, amidst growing reluctance for further support,” he says.

Greece apart, Portugal too has nothing positive to offer. Its new government, an uneasy coalition of foes, has sworn allegiance to the EU and the euro but is seeking major concessions. “With the highest total debt-to-GDP in the EU, a Portuguese debt restructuring, explicit or de facto, is not unimaginable,” Das says.

Despite positive talks, Spain’s public finances remain poor and unemployment unsustainably high. The recovery remains uneven with excessive reliance on domestic consumption and exports, primarily automobiles, to other European countries. With no clear winner emerging in the 2015 election, Spain remains vulnerable to political instability.

Adding to all these woes is Europe’s refugee crisis. “The current refugee situation in Europe is incredibly complex.  However, it is worth noting that the productive capacity of Europe has increased through the influx of a large number of additional workers,” says Kemp. The key challenge faced by governments is how to quickly integrate these new arrivals and manage the additional strain on the social infrastructure of the countries they settle in.

Das says that though Europe’s refugee crisis may boost economic activity but it is expensive, at around €10,000 per refugee per year initially, putting pressure on weak finances. “It has also highlighted deep divisions within the EU. Serious opposition to immigration and free movement of people required by the Schengen treaty has emerged.”

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