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Global Roundup

May’s Cabinet reboot descends into chaos. United Kingdom Prime Minister Theresa May’s attempt to give her government a 2018 reboot was marred by a chaotic Cabinet reshuffle as senior ministers refused to follow her orders. It’s a development that bodes ill for her ability to successfully navigate the next, even trickier stage of Brexit talks. (Business Mirror)

EU trade in 2018: A preview. The year 2018 will offer a very narrow window of opportunity to bring key EU trade policy files forward. (EurActiv)

World Bank: Permanently lower your hopes for the global economy. The World Bank’s assessment of the global economy starts off well. We’re in the midst of a “broad-based cyclical upturn,” which is expected to last several years. Annual global GDP growth is forecast to rise to 3.1% this year and stay at this level or just below until 2020. But this rosy picture of the present is tempered by a stark warning about the future. (Quartz)

Indonesia elections: Three factors that will shape the political trajectory of 2018. For Joko (Jokowi) Widodo, the first Indonesian president elected from outside Jakarta's elite, the combination of disruptive global forces and the intrinsic features of Indonesia's contemporary polity tested both his leadership and the nation's stability in 2017. Three aspects of Indonesia's contemporary polity are worthy of close attention in the year ahead and beyond. (Interpreter)

South Korea’s Moon open to meeting Kim ‘under right circumstances.’ South Korean President Moon Jae-in vowed to never accept North Korea’s nuclear program, while also saying he was prepared to meet Kim Jong Un under the right conditions. (Bloomberg)

China, South Korea reset bilateral ties. On Dec. 13, after a year-long feud, South Korean President Moon Jae-In traveled to Beijing for the first time since his inauguration in an attempt to rebuild the two countries’ relationship, which has been damaged by the presence of the United States’ Terminal High-Altitude Area Defense missile defense system in South Korea. (Global Risk Insights)

Canada: Step Up on NAFTA Talks, Says US Agriculture Secretary. U.S. Agriculture Secretary Sonny Perdue took a jab at Canadian negotiators, suggesting they were not aimed at concluding NAFTA talks successfully. (Global Trade Magazine)

Cheese is the beef as EU-Mexico trade talks resume. The EU and Mexico resumed talks last Monday aimed at sealing a new version of their 18-year-old trade deal, a project that has hit several snags – including the touchy issue of cheese. (EurActiv)

Fitch: Global Rating Outlooks Most Positive Since Crisis. The prospect of rating upgrades outnumbering downgrades this year and next is higher than at any time since the financial crisis, Fitch Ratings said in its latest global Credit Outlook report. (Fitch)

Global Output Gap Closing?

Chris Kuehl, Ph.D.

According to the latest World Bank assessment, the global economy is finally recovering fully. This would mark the first time that anybody could assert this since 2008 and the near global collapse of the financial system. When there is a gap between what an economy is capable of and what it is actually doing, there is a problem. This creates weak consumer demand, an excess of spare capacity, high levels of joblessness and very low inflationary pressure.

To some degree, the closing of the gap is indicated by the fact these issues have become less urgent. In the last few years, there have been several major economies that have seen their gap issues fade, while the global gap was persistent. It takes recovery throughout the world for the gap to fade globally. Today, there has been substantial recovery in the U.S., Europe, China and Japan as well as in many of the developing nations. Not every nation has seen this recovery, but more are than are not.

In general, this is a good thing, but it also means that there will be substantial changes as far as economic threats are concerned. For the better part of the last decade, there have been no inflation concerns, allowing a lot of policy moves and strategies in business. The central banks had the luxury of a low-inflation environment to work with, which allowed them to move very slowly as far as hiking rates. Today, there are still many in the central bank community advocating for a further extension of the low-rate environment. The business community had access to cheap money as well and, furthermore, had the luxury of time as they saw no immediate end to that largesse. The investment community also had access to cheap money. The access allowed a significant amount of risky buying. A surge in inflation—even a minor one—will change the equation dramatically.

The central banks will have to start worrying about overheating, which will prompt them to start raising interest rates higher than they have been in years. This triggers a whole set of reactions. The supply of cheap money dries up and leaves businesses with fewer options, while their inputs will become more expensive. They will likely react by trying to raise their own prices and create pressure for others in the supply chain. It all eventually lands with a thud in the laps of the consumer. The biggest impact may be felt in the investment community because there will no longer be cheap money available to propel those risky investment decisions. Some of the big bets that were attempted in the past will create big losses. The bottom line is that, for almost 10 years, the slack in the overall economy forced companies to keep their prices down to a significant degree. Now that pressure is being released, and companies will be tempted to make up for all those years of restricted pricing.

Although the levels of global growth have markedly improved over the last year or so, there remain threats to this pattern. The three threats that the World Bank has called out include the slump in productivity still affecting the developed economies in the U.S., Europe and Asia; the related threat of aging workforces; and the general slowdown in investment. Add in the likely reaction of the central banks to inflation threats and there are many reasons to assume the pace of global growth could slow once again.

Many of these threats are too difficult for any government to manage—at least in the short-term. There is not much that can be done about an aging workforce other than welcoming immigration or convincing people to start having lots of kids, but neither of these are rapid solutions. The productivity issue is also a long-term issue. The World Bank points out that some factors are well within the ability of governments to influence and the current policies are heading in the wrong direction.

This is not the time for a big fiscal stimulus, and that is precisely what the U.S. has embarked upon. When the looming threat is inflation and an overheated economy, the last thing needed is a big wave of tax cuts. The strategy makes perfect sense during a recession, but not when the recovery is finally in gear. There are, of course, ways to address inflation. These also come with a price and, if there is significant price and wage pressure, central banks are willing to push an economy back into recession as was the case in the 1980s.

Artificial Intelligence in Risk Management

Piyush Srivastava, RiskCounts LLC

In this increasing debate over artificial intelligence (AI), in how it is good for mankind and, on the other side, how it is going to take away our jobs, what is the right answer?

I would take the analogy of the advent of cars, trains or airplanes, in the times when people used horse carriages, horses or bullock carts. What was the advantage of a motor car or the train? Well, it reduced the time of travel, brought efficiency in terms of speed, reliability and saved valuable hours, and so did the creation of an airplane, which made traveling across the globe a viable and easier option for the masses. If we look at AI and machine learning today, it seems that it is no different from graduating from the horse driven carriage to a car.

Now, AI is affecting multiple areas of our lives, like AI-driven cars, back-office automations, machines learning to operate nonstop operations and doing tasks in minutes, what would take a person perhaps a week to do the same manually.

Risk Management is no exception to this. Fintechs and banks are introducing AI applications in risk management in a limited way, but these applications are also finding usage in the areas of investment decision making that is supported by huge amounts of data, hedge funds and asset managers using high-speed trading complex models. At the same time, phone-based market making is giving way to electronic execution. Market makers and asset managers are now looking to use technology and AI to assess the risk of the counterparties from the publicly and privately available data.

The increasing use of AI in risk management will have a profound impact in the way firms and financial services organizations manage their risk. A lot of emphasis is put on monitoring the risk in the operations with less focus on real analytics. With the increasing use of AI and machine learning, it is estimated that the focus of risk managers will shift toward analytics and stopping losses in a proactive manner, rather than spending time in managing the risks inherent in the operational processes.

Today, firms are developing operational risk platforms by scouring the internet for all-encompassing information about an organization with the help of machine learning and AI. The day is not far when traders, asset managers and risk managers will actively resort to AI-based platforms to monitor counterparty credit risk and operational risk of the entities that they are dealing with.

AI is here and it’s time for risk managers and financial services to embrace the benefits of this technology.

Source: RiskCounts

 

Venezuela’s Debt Restructuring Expected to be Long, Complex

Venezuela's debt restructuring process will likely be long and complicated by sanctions and the challenging political environment, said Fitch Ratings. Political changes and a comprehensive and credible economic plan will be needed to gain the market's trust in the durability of any reform agenda and debt restructuring terms.

Venezuela defaulted on its sovereign debt on Nov. 14, 2017, failing to make interest payments before the end of the 30-day grace period. Since the default, the government has accumulated missed interest payments totaling nearly $700 million.

At the same time, state-owned oil company Petroleos de Venezuela, S.A. (PDVSA) also failed to make payments on its debts with accumulated missed interest payments totaling over $800 million. However, PDVSA has made some late payments over the last two months, signaling a differentiation of the government's treatment of sovereign and PDVSA debt payments, at least in the near term.

In early November, President Maduro called for a debt restructuring and called a creditor's meeting in Caracas, which yielded no concrete results.

In Fitch’s view, the political and economic prerequisites for a debt restructuring are missing. Political changes would be required to address U.S. sanctions and re-engage the broad international creditor community, beyond Russia and China. A comprehensive and credible economic plan will also be needed to address the severe economic imbalances, the deep and prolonged recession, hyperinflation and reverse the sharp decline in oil production.

The government has sought to by-pass the opposition-controlled National Assembly by creating a new Constituent Assembly with powers over all other government bodies in July 2017. Additionally, the governing Partido Socialista Unido de Venezuela (PSUV) party further consolidated power in the Oct. 15, 2017, long-delayed regional election when it won 18 of the 23 governorships at play. The results have weakened and effectively split the opposition, resulting in greater political control for the Maduro government. Political talks between the government and parts of the opposition are ongoing in the Dominican Republic but have yielded no substantial results to date.

The government has failed to outline a credible economic strategy to arrest the deep economic contraction and hyperinflation. The economy contracted by an estimated cumulative 36% over the last four years, with a further contraction of 14% expected in 2018. Hyperinflation has taken hold, reaching an estimated year-end rate of 2,616% in 2017 and accelerating into 2018. Any credit positive economic plan would also reverse the sharp decline in oil production. Oil represents more than 95% of the country's exports and historically, nearly 50% of government revenues. OPEC data indicates that Venezuela's total crude production sharply declined to 1,837 thousand barrels per day (tb/d) in November 2017 from 2,270 tb/d in December 2016. Oil production will likely continue to decline in 2018.

Furthermore, U.S. sanctions greatly complicate a restructuring. The sanctions prohibit U.S. citizens or entities based in the U.S. from entering into financial transactions with the government and PDVSA, including any dealings in new debt and certain existing bonds owned by the Venezuelan public sector.

A successful debt restructuring can only happen after the political and economic prerequisites are in place. The legal challenges will also likely be complex. The default is therefore likely to be long and protracted given the enormous challenges Venezuela faces.

Source: Fitch Ratings

Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations