BRAZIL and Russia, the third- and fourth-biggest emerging economies, have much in common beyond their size. Each boasts annual GDP per person of around $10,000, which depends more than either would like on natural riches. After commodity prices tumbled in 2014, their economies shrank and their currencies sank. Their central banks have fought hard against the ensuing inflation, driving it below 3%. That has allowed both to cut interest rates, contributing to modest economic recoveries.
But their fiscal fortunes have diverged. Brazil’s credit rating was cut by Fitch on February 18th, making its sovereign bonds even “junkier” (ie, more speculative). Russia’s rating, by contrast, was raised a few days later by S&P Global, which became the second agency to rate Russian sovereign debt as “investment grade”.
That might seem an odd description for a country embroiled in two wars and encumbered by sanctions. But Russia’s upgrade is not hard to justify. Though its approach to geopolitics is adventurous, its approach to macroeconomics is deeply conservative. Indeed, in many ways Russia’s geopolitical adventurism has necessitated its economic conservatism.
“The whole Russian economic policy, starting from the president, is focused on keeping inflation low, ensuring that the budget is stable, and that reserves are moving up,” says Oleg Kouzmin of Renaissance Capital, an investment bank. It is a “very defensive” strategy, argues Timothy Ash of BlueBay Asset Management, designed to help Russia weather future sanctions and build defences against the West.
When oil prices fell in 2014, Russia’s government realised that belts needed to be tightened. After a brief struggle, it let the rouble fall. It squeezed demand by hiking interest rates and cutting public spending. From 2013 to 2016, GDP per person fell by over 40% in dollar terms. In its realism and rapidity, Russia’s response to its crisis was the best of any emerging market this decade, says Mr Kouzmin.
The government’s deficit now stands at just 1.5% of GDP. Its net debt is only 8.4% of GDP. This conservatism may persist. Its latest fiscal rule requires it to assume an oil price of $40 a barrel, even though the Urals oil price is now over $64.
Brazil also has a stringent fiscal rule, obliging it to freeze federal spending in real terms for 20 years. But the government has yet to bring its other commitments into line with this limit. An attempt to delay pay hikes for civil servants was blocked by the supreme court. And an essential reform of pensions was watered down in negotiations with congress, which then refused to support it anyway.
Brazil suffers from a fiscal “tragedy of the commons”. Its jostling lawmakers overgraze, demanding too much from the state, because if they do not, they know their rivals will. By contrast, Russia’s president and chief policymaker, Vladimir Putin, has few rivals for his fiscal pasture. That makes him keen to preserve it.
Russia’s economic defensiveness is good for its credit rating, but may have an unwelcome side-effect: squashing growth. More relaxed fiscal and monetary policy would give the economy room to breathe, argues Mr Ash. “What is the point of having a good balance-sheet if your economy is not growing?”
And Mr Putin’s reluctance to cede control may be stymieing the reforms Russia needs. If it is to grow, the state must allow new entrants, including foreigners, to prosper at the expense of incumbents. Instead, entrepreneurs are well aware that they prosper only at the regime’s pleasure. “Do you ever really own anything in Russia?” asks Mr Ash. Fiscal entitlements are too secure in Brazil. But in Russia, property rights are not secure enough.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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