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Beyond Ratings Weekly Digest

Your briefing on augmented financial risk analysis

N°150 ▪ 21st June 2018


Illegal drugs in the GDP: short-term gain but long-term loss

A few weeks ago, the French National Institute of Statistics (INSEE) decided to include illegal drug trafficking in the calculation of GDP (for an additional amount of at least EUR 2.7 bn). This followed a 2013 Eurostat request that aims to make such practices widespread in the EU, after previous moves by countries such as the Netherlands to include prostitution and drugs in the GDP.

However, such a decision is questionable. In theory, GDP aims to measure (mainly) economic value added in the most accurate possible way, but is this really what is measured by the consumption of cannabis, cocaine or new Chinese psychoactive substances? And can a statistical approach be sufficient to answer this question given its cultural implications on the status of drugs in relation to socio-economic development? Such a decision sheds light upon the very diverse nature of the elements that are taken into account in GDP. Moreover, it highlights the limits of GDP, thus calling for other indicators as those developed by ESG assessments.

Let us start with a few words on the illegal drugs market as this is today’s subject. As detailed in a recent EMCDDA report published almost at the same time as the announcement of the French statistical decision, drug use is “a recognized cause of avoidable mortality among European adults” (c.8,000 deaths in 2016, with notable under-reporting issues). In addition, drug-induced deaths are increasing in almost all age categories. For a given age and sex category, European opioid users are five to ten times more likely to die than their peers, with mortality rates that can reach 1-2% per year for high-risk drug users. While this situation is better than in the USA (64,000 deaths in 2016 and a 22% overdose death rate increase in just one year), but it remains serious.

Drug-induced deaths reported in the EU in 2012 and 2016 (or most recent data) by age band

And of course, mortality is not the only problem associated with illegal drug use. Cannabis (of which Canada has just announced the legalization) tends to present different risks but its impacts in terms of addiction, mental health issues, bronchitis or fertility loss, etc. should not be underestimated. Just to give an example, a 1987 Swedish study assessed that people who used cannabis more than 50 times before the age of 18 were three times more likely than others to have schizophrenia at 45 (which has also been supported by other studies since then). And there are still many things that we do not know about drug effects that call us to caution, especially given the delicate and deep matters at stake involving both bodies and minds.

So, as the US opioid and current trends in developed countries make clear, there is a drug problem. However, this also poses questions that are beyond the question of drugs, bringing us to the question of the quality of our economic indicators given the recent inclusion of illegal drugs in GDP. GDP has become the dominant indicator to measure the economic value produced every year by any given region, country or the world. GDP per capita is in general the most common indicator of wealth and a key factor as for example in conventional sovereign ratings. But what if part of this “wealth” is in fact toxic or has negative side effects at least in the medium or long term? And what if it reflects social problems, suffering and dissatisfactions, as can be the case of drug use and its growth?

These are actually examples of questions raised by the development of ESG analysis, as in our methodology to adjust GDP based on ESG criteria. Indeed, if drug use causes deaths or even just harms social relationships, family structures or professional lives, indirect negative impacts can be significant even if they are not factored in. A similar view applies when ESG analysis highlights the potential negative impacts in the long-run of excessive dependence on fossil fuels, poor governance or low education and health performance. For a given quantitative level, all GDPs are not equal and do not present the same resilience. Societies can truly be weakened by some of their GDP-generating activities (at least through externalities), and even if impacts can be mainly long-term, this type of risks should also be considered. Compared with GDP from these activities, GDP from competitive industrial sectors or essential services obviously brings something more. And this “additional” value can serve the whole economy and society, such as when a new bridge is built compared with the refurbishment of a damaged bridge (which can by the way be also an ESG or climate-related risk).

Lastly, it is a real question to see that illegal drugs are now included in the calculation of GDP for more and more countries while a range of non-market but highly valuable activities are not really taken into account, such as free volunteer work and parents’ work at home to take care of children (unlike similar work conducted by childminders). Trying to measure everything or focusing on an economic perspective indeed has limits.

This is not to say that we should give up on the GDP. The GDP offers a synthetic view of the size and dynamic of an economy without which it would be difficult to conduct macro-financial analysis of sovereign assets. However, the recent French statistical move provides a good illustration of its limits. Even economic data are not perfect, and this can result in notable biases. A few years ago, in Ireland, accounting changes to include drugs and prostitution in the GDP had led the 2013 GDP growth to be revised from a 0.3% loss to a 0.2% increase.

This also strengthens the case for going beyond GDP to integrate a clearer view of the environmental, social and governance impacts of our activities, with a more long-term perspective. While freedom is generally highly valued (and is even in the French national motto), addictions paradoxically seem to continue to take a notable socio-economic toll in our societies (see also alcohol, tobacco, food, TV/internet, gambling, the tragedy of prostitution, etc. or even the fact that the WHO just recognized a few days ago that addiction to video games can be a disease). However, real freedom participates to the common good and this also matters for economic and social resilience based on a broad ESG perspective.

Guillaume Emin, Project Manager  –  Sources: Beyond Ratings, EMCDDA



Sovereign Risk

ECB monetary policy: not surprisingly?!

On Thursday June 14th, the European Central Bank (ECB) decided to end its quantitative easing (QE) at the end of the year. While this news wasn’t a surprise, the timing of the first rate hike was slightly different from to market expectations. Debt purchases under the QE launched in 2015, which totaled EUR 2,550 billion, will be reduced from EUR 30 billion per month to EUR 15 billion between October and December, and then will finally cease. Indeed, the ECB Board of Governors plans to keep interest rates at their current level until – at least – the end of summer 2019 and “as long as necessary” to ensure that inflation remains in line with its objective. As a reminder, the refinancing rate, the main instrument of monetary policy, remains fixed at zero, the deposit facility rate at -0.4%, and the marginal lending facility rate at 0.25%.

At the end of the day, the ECB will adopt a “patient” and “gradual” approach when raising interest rates to accompany the recovery from inflation in the Eurozone. Several options are available to the Frankfurt-based institution. On the one hand, the date of the first interest rate hike could very likely be at the Monetary Policy Committee on September 12th or October 24th of 2019. On the other hand, the first rate hike could (i) only affect the deposit facility rate by 15 bps in order to bring the rate corridor back to its original configuration, i.e., a 25 bps spread between each of the three rates or (ii), the three rates at the same time and therefore a first hike of the refinancing rate, thus withdrawing it of the zero lower bound it was fixed on March 2016.

Julien Moussavi, Head of Economic Research  –  Sources: Beyond Ratings, ECB


Is Bitcoin an ESG nightmare?

Bitcoin energy consumption relative to several countries

Depending on the evaluation method used, the energy consumption of cryptocurrencies can be comparable to countries such as the Czech Rerpublic or Ireland. This is no less than 71 TWh yearly that are necessary to feed the monster. Considering an average CO2 intensity of 0.5 kCO2/kWh, we reach a total of 36 MtCO2 – more or less the total Greenhouse Gas (GHG) emissions of Slovakia. This probably a quite conservative approach because computers are in high CO2 intensity countries (China, Russian Federation,…). A bitcoin transaction uses 500,000 times more power than that of a credit card.

Moreover, cryptocurrencies (Bitcoin, Ethereum, etc.) are used for out-of-the-official-market transactions, such as tax evasion, illegal products purchases and any other borderline activities. In other words, the use of cryptocurrencies impacts tax revenues and facilitates access to drugs, arms, and prostitution/illegal pornography.

From a governance point of view, legislators have just begun to understand that a currency-like object should be regulated to avoid price manipulations, and they are about to understand that decentralized activities are difficult to supervise. However we can’t deny that crypto-currency is an expression of freedom and mistrut. This is a kind of local currency in a global village.

Emeric Nicolas, Head of Statistics  –  Sources: Beyond Rating, Joule, Digiconomist 

Carbon/Climate Change

A quick look at the diversity of financial intermediary roles

Global GHG emissions and financial intermediary roles (external financing only)

Note: Data on financing shares are illustrative only and do not reflect actual ratios

The ultimate goal of finance is to connect economic agents who need financing with agents that can provide it. However, agents and financing needs are so varied that the role of banks as financial intermediaries is equally diverse: from retail banking to portfolio investment and asset management, as well as corporate or investment banking. This is all very well, but how to track the GHG emissions associated with these financial channels? This is exactly what today’s graph (from WRI/UNEP-FI/2°II) tries to roughly represent. On this graph, only agriculture, land use, land use change and forestry (AFOLU) emissions are not mapped with their financing sources. For the rest, two things can be noted: (i) most emissions are generated by industry, buildings and road transportation, and (ii) these emissions are linked to both banking balance sheets and to securities sold to investors.

Several other key facts should also be noted. First, the role of investors is closely linked to industry’s emissions (through corporate bonds and equity), and to some extent to buildings, but it should be noted that a significant share of emissions is linked to other financing channels. For example, greening corporate credit and mortgages is also a challenge. Second, this graph reminds us that sovereign debt requires a specific treatment. Based on government-owned assets, government bonds might seem not to be an issue. However, governments play a key role as regulators beyond their direct impacts, and the share of government debt in total debt is huge (not visible on this graph). Out of USD 233 tn of global debt at the end of Q3 2017, 27% was government-related. Finally, this global picture confirms the key role of banks and investors. Not only do they finance the other agents (except when it is financed by household equity or public budget surpluses), but financial institutions also have significant amounts of debt to repay (25% of the world’s total).

Guillaume Emin, Project Manager  –  Sources: Beyond Ratings, IPCC, WRI/UNEP-FI/2°II, IIF


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Photo credit via Visualhunt/CC BY-SA or other: Front page ▪ Credit 1: CECAR – Climate and Ecosystems Change Adaptation R; Credit 2: Tony Webster; Credit 3: Kiefer.; Crédit 4: NASA Goddard Photo and Video / Research notes ▪ Credit 1: DnDavis (via; Credit 2: zhu difeng (via Fotolia); Credit 3: Mny-Jhee (via Fotolia); Credit 4: xmentoys (via Fotolia)


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