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Beyond Ratings Weekly Digest

Your briefing on augmented financial risk analysis

N°142 ▪ 19th April 2018


What about Trumponomics? Limits and consequences of an increasing budget deficit

Trump’s decisions about fiscal policy in the coming years have surprised analysts. Indeed, its fiscal plan consists in lowering taxes and increasing spending in infrastructures and defence. However, this fiscal expansion is being pursued while the unemployment rate is at a lower point (continuously below 5% since September 2015) and economic activity is at a good level (with a real GDP growth rate at 2.3% in 2017 up to 2.9% in 2018 according to the IMF forecast). In this case, this is a pro-cyclical fiscal expansion which would only increase risks of overheating economy and increase the public debt. Furthermore, it could lead to serious impacts on yield curve and FED’s monetary policy.

United States Budget Balance and Real GDP Growth Rate: Evolutions and Forecasts

Sources: Congressional Budget Office, Oxford Economics, Beyond Ratings

While this fiscal expansion could improve the GDP growth rate in the short term, it will have no effect on potential growth. The Congressional Budget Office forecasts a GDP growth rate below the potential output from 2021. Indeed, improving the potential growth requires higher population growth and/or higher productivity growth. None of these will be impacted by Trumponomics.

Most important, this pro-cyclical policy with tax cuts will only benefit higher income households. Indeed, as underlined by a recent study, taxes for the  three bottom quintiles  will increase due to the Tax Cuts and Jobs Act Agreement, while taxes cuts for the 5 last centiles will be significant. This increasing budget deficit will thus increase the public debt and notably feed the rising income of the richest. The increasing inequality has led to an exponential growth of private debt in the 2000s which caused that lower and middle income have run into debt in order to maintain their purchasing power. Thus, the increase in inequalities could again cause a financial bubble as it happened in the global financial crisis.

This pro-cyclical fiscal policy will also have impacts on the sovereign yield curve and FED’s monetary policy. Indeed, this increase of public deficit has two financial adjustment mechanisms: by the interest rate and by the exchange rate.  First, an adjustment of the sovereign interest rates can occur through faster hikes from FED or by higher risk premiums. Hence, this increase of interest rate attracts needed capital (foreign and domestic) to finance the government public deficit. Secondly, a possible adjustment could come through an exchange rate adjustment. Thus, as increasing public deficit is financed by an increasing external debt, US dollars denominated external debt value could increase due to a weakening exchange rate.

United States Government 2Y and 10Y Rates

Sources: Source: Thomson Reuters, Beyond Ratings

The first financial impacts on yield curve can already being observed: at this moment, the spread between long-term (10-year) and short-term (2-year) rates on the United States is about only 43 basis points. As underlined by the chart above, a flattering yield curve was observed just before previous financial crises (in 2000 and in 2006-2008).

Thus, while this pro-cyclical fiscal policy aims at improving US economic activity on the medium term, it could sow the seeds of the next global financial crisis…

Gabriela Aguilera-Lizarazu and Thomas Lorans



Sovereign Risk

The IMF remains optimistic in the short term!

According to its last spring publication of the World Economic Outlook, the International monetary fund (IMF) remains optimistic in the short term. Indeed, the Fund is forecasting global growth at +3.9% both in 2018 and 2019. Advanced economies are expected to account for most of the forecasted increase for 2018 – the growth forecast expands in the United States mostly thanks to Trumponomics and Eurozone growth above its potential – while emerging market and developing economies are expected to take over as early as 2019, notably thanks to a significant growth come back in Brazil and South Africa.

At the same time, the Washington based institution warns once again that this short period of strong economic conditions must be useful to implement structural reforms to improve the potential growth of advanced economies in the medium- to long-term. The French case is emblematic of this IMF recommendation.

Sources: Beyond Ratings, IMF WEO


SDGs: an attempt to square the circle?

In a general manner, all sustainable goals are morally desirable. Who could consciously ask for more poverty, more hunger or more violence in the world? Who could argue that pollution, biodiversity loss and high natural resource depletions are positive things? With the exception of certain economic domains (e.g. arms dealers, usurers, highly-polluting industries etc), there is a global consensus about the goals’ merits.

But are desirable goals sustainable? As defined at the World’s first Earth Summit in Rio in 1992, sustainable development is one that “that meets the needs of the present without compromising the ability of future generations to meet their own needs”. Depending on forecasts we might have for next generations, that are necessarily biased by today’s social and economic vision, current development goals could be sustainable…or not. More dramatically, the 8th goal is structurally inconsistent with most of the other goals. Indeed, how could we reduce our global footprint in a growth situation? How could we achieve Goals 8.1 (sustained per capita economic growth) and 8.5 (full and decent employment) in a finite planet? Easy, Goal 8.4 answers: “increase efficiency…and endeavour to decouple economic growth from environmental degradation”. No more energy needs, no more Greenhouse gas emissions, no more raw material needs…what kind of needs could future generations meet in this out-of-reality world?

Sources: Beyond Ratings

Carbon/Climate Change

The uneven distribution of the benefits of the energy transition

Impact of the energy transition on GDP

GDP impacts in select regions & countries – the REmap Case compared to the Reference Case, 2050 (%)

If you are interested in renewables, you are probably interested in what IRENA does and the work of their REmap team. REmap (renewable energy roadmap) is a global roadmap based on a scenario of massive development of renewables and energy efficiency (with respectively USD 22 tn and USD 53 tn of investments between 2015-50 vs. USD 10 tn and USD 29 tn in IRENA’s reference scenario). In REmap, renewables would make up 60% or more of many countries’ final energy use. But what would this mean for the economy? IRENA recently published a detailled report on REmap in which it looks at impacts on GDP. Interestingly, relative impacts are positive in most developed countries (Europe, USA…) or at the G20 level. But IRENA’s analysis also provides a good illustration of a key issue: i.e. REmap would represent an opportunity cost for most of Africa, Russia or the Middle East.

Some of these issues may be partly solved through negotiation and cooperation (e.g. development aid with Africa), but what about the relationships with Middle East or Russia? A positive element is the fact that expected impacts on employment could be more positive overall in most countries (and GDP cannot be the only economic criteria), but it is clear that the non-alignment of interests across countries remains one of the key challenges of the energy transition, even beyond this scenario.

Sources: Beyond Ratings, IRENA


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