Is World Economy Trapped in Death Spiral

Let me first of all refer to a news item that CNBC has reported. It says the global economy seems trapped in a "death spiral" that could lead to further weakness in oil prices, recession and a serious equity bear market. It also says that some analysts have turned bearish on the world economy this year, following an equity rout in January and weaker economic data out of China and the U.S. The other explanations include:

1. U.S. dollar has risen by around 20 percent against a basket of currencies.
2. Crude oil prices have tumbled by around 70 percent since the middle of 2014.
3. The dollar would weaken in 2016 and that oil prices were likely bottoming, potentially providing some light at the end of the tunnel.
4. The forecast reflects expectations of gradual improvement in countries currently in economic distress.
5. The various factors would lead to significant and synchronized' global recession and a equity bear market.
6. The silver lining is that the world economy will grow by 3.4 percent in 2016 according to the International Monetary Fund.

These are the excerpts from a report from the developed world prepared by the wiz kids. However, a person like me who belongs to the third world could only laugh at the amateurish approached of a leading international broadcaster.  I would term it ‘an attempt to mislead the audience’ as the media houses operate on the advice of ‘lobbyists’.

To substantiate my point it suffices to say that the global media has been talking about declining number of oil rigs in the US but oil output does not show any corresponding reduction, on the contrary output is on the rise. Reportedly number of active rigs has come down to less that from peak of over 1600.

Lately the World Bank has also warned that global growth rate would come down due to ongoing wars in the Middle East. Interestingly the developed world pushes the countries into proxy wars and then basing these create huge and cry about plunging economies.

I will conclude on the point that the US and Saudi Arabia were partners in taking oil prices to record high and now the animosity between the two is responsible for the rock bottom prices.

Previously the wars were fought with arms but now countries are subjugated by destroying their economies. The most glaring example disintegration of USSR and other living examples are Iran, Iraq, Libya, Nigeria and Sudan.

The moral of the story is that the death spiral is in nobody's interest but rational behavior, most likely, will prevail over. But the broadcaster has shown only one side of the coin. Now it is up to the audience and readers to find out the motives of super powers, their modus operandi and above all the disinformation spread to mislead the people, especially those who are being exploited.

Why analysts are talking about declining oil prices only?

Somewhere I read a story about the energy giants ‘seven sisters’ which virtually control the global economy. All analysts are talking about declining earnings of these companies but not about the benefits of low oil prices. The same is also true about Pakistan where analysts are too worried about earnings of less than half a dozen oil & gas exploration companies but hardly demand the government to stop persistent hike in taxes on petroleum products.

A few months back I raised a question in one of my blogs, who are the beneficiaries of declining oil prices? At that time my own inference was that the US is the biggest beneficiary, being the largest consumer of energy products. After lapse of a few months I still withstand my point of view. I even go to the extent of saying that not only all other oil producing countries are plunging into serious financial crisis but Saudi Arabia and Russia are worst hit. Lower oil prices may keep proceeds from oil export low for Iran but it may gain the most after easing of sanction it had endured for more than three decades. Its non-oil exports are likely to increase substantially and it may also succeed in attracting enormous foreign direct investment in virtually every sector. 

Declining oil prices have enabled the US in increasing its strategic reserves, oil imports remain high and indigenous oil production still hovers at record high levels, above 9.2 million barrels a day. Reportedly the US crude inventories have surpassed the 500 million barrels milestone. Two of the global benchmarks WTI and Brent bounced up and down throughout the week ended on 5th February. However, faltering global economies offer a chance to the US Fed not to hike the interest rate, resulting in weak dollar and pushing oil price higher again. 

The western media is now trying to create an impression that the collapse in oil prices is now bleeding over into the broader global economy. They talk about the ongoing down turn in oil exporting countries, from Saudi Arabia to Russia, Venezuela, Iraq, Nigeria, and more. They have strange rationalization that cheap energy should bolster consumption, but the drop in commodity prices has been so sharp that questions continue to arise about the creditworthiness of some oil producers, Venezuela tops the list. With billions of dollars in debt due this year a rapidly shrinking ability to deal with the crisis, a debt default may not be too far off.

Citigroup added its voice to those concerned about the health of the global economy, citing four interlinked forces – a strong U.S. dollar, low commodity prices, weak trade, and soft growth in emerging markets – for the sudden fragility and potential for a global recession. "It seems reasonable to assume that another year of extreme moves in U.S. dollar (higher) and oil/commodity prices (lower) would likely continue to drive this negative feedback loop and make it very difficult for policy makers in emerging markets and developing markets to fight disinflationary forces and intercept downside risks," Citigroup analysts warned.

ConocoPhillips (NYSE: COP) made news this week when it became the first US-based oil major to slash its dividend. Italian oil giant Eni (NYSE: E) was the only other oil major to have done so – it cut its dividend almost a year ago. ConocoPhillips cut its dividend by 65 percent this week, and the company’s CEO argued that the move would save $4.4 billion in 2016.

The oil majors are having trouble covering spending and also their shareholder payouts with their underlying cash flow. By and large, they are making up for the shortfall with new debt. Chevron took on an additional $9.6 billion in debt to cover dividend obligations, ExxonMobil added $10.8 billion in fresh debt, and BP took on another $4.6 billion. At some point, something has to give. S&P downgraded a long list of oil companies this week, including Chevron and Shell. It also put BP and ExxonMobil on review for a possible downgrade.

A quick rundown of the full-year earnings from some of the oil majors:

•    BP (NYSE: BP) lost $6.5 billion in 2015, one of the company’s worst on record.
•    ConocoPhillips (NYSE: COP) posted a loss of $4.4 billion in 2015.
•    ExxonMobil (NYSE: XOM) saw profits halve to $16.2 billion.
•    Royal Dutch Shell (NYSE: RDS.A) posted a profit of $3.8 billion, down 80 percent from 2014.
•    Chevron (NYSE: CVX) reported a loss of $588 million, its first loss since 2002.

KAPCO likely to post robust earnings growth

Pakistan’s largest independent power producer (IPP), Kot Addu Power Company (KAPCO), is scheduled to announce its second quarter (2QFY16) financial results on 23rd February 2016. The Company is expected to post profit after tax of Rs2.6 billion (EPS: Rs2.94) for 2QFY16, showcasing muted growth of 7%YoY taking 1HFY16 cumulative profits to Rs4.7 billion (EPS: Rs5.34). The Board of Directors is also expected to approve payment of an interim dividend of Rs4/share, where upside may stem from improved liquidity.

Earnings are likely to be a function of: 1) load factor of 57% as compared to 61% for the corresponding period year, 2) increased generation on gas (18.7% of units generated as compared to 5.5%) allowing for higher efficiency coupled with O&M savings and 3) drastic (68%YoY) dip in finance charges in part due to falling cost of borrowing, and lower working capital requirements from falling input costs.

Assessing the heavily regulated and GoP reliant nature of the Power sector, KAPCO bears risks in the form of: 1) liquidity concerns hampering payouts as the company had a negative spread on receivables as compared to payables, relying on short term loans to fill the gap, 2) mechanism for generation on LNG yet to be sorted, with standby letters of credit a possible roadblock and 3) delay in planned privatization due to the process being devoid of technically sound sponsors.

OGDC to add LPG plant at Naspha field

Nashpa field of Oil and Gas Development Company (OGDC) is located at District Karak of Khyber Pakhtunkhwa. It is rich in hydrocarbons and capable of producing daily 1,032 barrel oil, around 125 mmcfd (million cubic feet gas per day) gas and liquefied petroleum gas (LPG).

A 380 metric ton LPG plant  would also be installed in March this year. The LPG project will be completed in two years and local manpower will be hired for running the plan at the field located at District Karak of Khyber Pakhtunkhwa. The field has been discovered recently having oil and gas.

State Bank of Pakistan could not gather courage to cut policy rate

On Saturday, 30th January 2016 the newly constituted Monetary Poly Committee (MPC) of State Bank of Pakistan (SBP) decided to keep the Policy Rate unchanged at 6.0 percent. This was a little disappointing for those, hoping against the hope. The general perception was that the MPC will find reasons for not announcing the cut, and this happened. Interesting is the review of the economy but disappointing is the decision as it shows inability of the policy makers to take an appropriate decision.

The good points of the review of economy by the SBP are as follows:

The major macroeconomic indicators continued to exhibit improvements in the first half of the current fiscal year. The inflationary environment stayed benign, LSM gained traction, and fiscal consolidation remained on track. In addition, successful completion of ninth review under IMF’s EFF and disbursements from multilateral and bilateral sources added on to country’s external buffers. With the pickup in private sector credit, for fixed investment in particular, along with improving security situation reflects strengthening of investor and consumer confidence.

Average CPI inflation declined to 2.1 percent during July-December 2015, with perishable food items and motor fuel leading the way. Meanwhile trend in YoY CPI inflation has reversed; it rose for third consecutive month to 3.2 percent in December 2015. Keeping in view the benign outlook of global commodity prices, expectation of a moderate pickup in domestic demand and further ease in supply side constraints, SBP expects the average inflation in FY16 to remain in the range of 3 to 4 percent. However, global oil price trends and excess domestic food stocks (wheat, rice, and sugar) may exert downward pressures on inflation.

Large-scale manufacturing (LSM) grew by 4.4 percent during Jul-Nov FY16 as compared to 3.1 percent in the same period last year. LSM mainly benefitted from monetary easing, falling international prices of key inputs, better energy situation, increased domestic demand for consumer durables, and expansion of construction activities. There are challenges to overall economic performance from the declines in the production of cotton and rice. However, a part of these losses could be offset by better performance of other crops, especially from the upcoming wheat crop. In view of these developments, real GDP is set to maintain the previous year’s growth momentum. The uptick in economic activity appears to continue beyond FY16 on the back of energy and infrastructure projects under CPEC.

Pakistan’s overall balance of payment position continued to strengthen during H1-FY16. The external current account deficit narrowed down to almost half of the last year’s level on account of persistent decline in international oil price and steady growth in workers’ remittances. In the capital and financial accounts, besides strong official inflows, there is some improvement in foreign direct investment.

Given depressed outlook of international commodity prices, the external current account deficit is expected to remain lower than last year. With continuation of the IMF EFF and expected disbursements from other official sources, the surplus in capital and financial accounts may increase in the second half of FY16. These are expected to have favorable impact on foreign exchange reserves. Furthermore, expected increase in FDI from China may help maintain an upward trajectory in foreign exchange reserves. Reversing of trends in exports, however, is dependent on external demand and cotton prices in international market. In addition, easing of domestic constraints with the completion of ongoing energy projects could help in improving export competitiveness.

Fiscal deficit was contained to 1.1 percent of GDP during Q1-FY16, compared to 1.2 percent in the same period last year. This reduction, despite substantial increase in development expenditures during Q1FY16, was due to improvement in tax revenues and containment of current expenditures. The improvement in fiscal accounts may continue in the remaining months of FY16. While additional tax measures announced in October 2015 are expected to contribute to growth in FBR revenues, current spending is likely to remain within target.

The year-on-year growth in broad money (M2) accelerated largely due to substantial increase in Net Foreign Assets (NFA) of the banking system. The growth in Net Domestic Assets (NDA) of the banking system decelerated despite a pickup in private sector credit. On the liability side, deceleration in growth of deposits and acceleration in currency in circulation are source of concern.

The credit to private sector increased by Rs339.8 billion during H1-FY16 as compared to the Rs224.5 billion in same period last year. The impact of monetary easing, improved financial conditions of the major corporate sector and better business environment encouraged firms to avail credit not only for working capital requirements but also for fixed investments. Going forward, the improvements in LSM, expansion plans announced by major industries and favorable monetary conditions are expected to provide continued momentum in the demand for credit.

Some stress in liquidity noticed in Q1-FY16 due to increased government borrowing from the scheduled banks steadily eased in Q2-FY16 owing to improved revenue collection and timely receipt of foreign flows. Besides this, pressures in foreign exchange market also induced volatility in interbank liquidity requirements. This is also evident from movements in overnight repo rate which mostly remained slightly above the SBP target rate.

Will State Bank of Pakistan cut the discount rate?

Governor State Bank of Pakistan (SBP), Ashraf Mahmood Wathra is scheduled to unveil Monetary Policy Decision at a press conference on Saturday. There are mixed opinion of groups due to each having its own vested interest. The commonsense is not likely to prevail as those responsible for making decision are likely to take refuge behind external and internal dictate.

Based the economic indicators the SBP should announce reduction in discount rate to: 1) facilitate private sector borrowing, a must for accelerating GDP growth rate, 2) emulate the develop countries adamant at easing monetary policy for combating prevailing global economic slowdown and 3) reduce cost of borrowing, as the Government of Pakistan (GoP) remains the biggest borrower.

Many economic analysts say that the rule of thumb that higher rate of interest fuels inflation is hardly applicable on Pakistan. The country suffers from cost pushed inflation. The factors like global prices of food and energy products, cost of doing business, electrify and gas outages and above all precarious law and order situation erodes competitiveness of local manufacturers and exporters.

While there are expectations that the SBP will cut the discount rate by 50 basis points, few cynics still believe that the central bank is likely to opt for maintaining status quo. This perception is based on the mantra that spreads of commercial banks are shrinking.

Since commercial banks are the biggest investors of Treasury Bills, Pakistan Invest Bonds and Government of Pakistan Ijara Sukuk there is pressure on the central bank not to cut the discount rate.

As against this sponsors of highly leveraged companies like sugar, textile and cement (also enjoying access to power corridors) are putting pressure on the government to reduce the discount rate. Business of the companies belonging to the above stated sectors has thrived only because of the crutches of the government support.

One may recall that the Government recently approved payment of Rs13/kg subsidy, amounting to Rs6.5 billion on sugar export to facilitate mills owned by the politicians (treasury as well as opposition members).

The retired persons and widows also wish that the central bank should not cut the discount rate further as the return being paid to them by the banks as well as on national savings schemes at present is negative keeping in view the rate of inflation in the country.