July 2017

Country Ranking Trends

  • Magni completed a review of Russia’s banking supervision. The stress on Russia’s banks from international sanctions has exposed incomplete implementation of previously announced programs to strengthen supervision. The resulting weaknesses are material and have resulted in Magni downgrading Russia. The combination of this downgrade with prior upgrades of China has placed Russia at risk of being ranked lower than China for quality of governance.

Have You Heard Poland’s Version of AC/DC’s “Highway to Hell”?

  • In a surprise move, following large protests and international disapproval, the Polish president Andrzej Duda has vetoed two of three controversial bills on judicial reform that had been passed by the ruling Law and Justice (PiS) party. President Duda has been a reliable supporter of the PiS agenda, but he said the vetoed laws gave excessive powers to the prosecutor general. One of the bills Duda vetoed was intended to put new controls on the Supreme Court, making the justice minister, who is also prosecutor general, responsible for appointing judges. The legislation would also have triggered the immediate dismissal of all the current Supreme Court justices. The second bill would have given lawmakers power over the National Council of the Judiciary, which is responsible for recommending judges for appointment. The president did, however, sign a third bill, which grants the justice minister the power to hire heads of local courts.
  • Implications: The populist and autocratic tendencies of the PiS party created the current crisis. Poland’s relatively high Magni Country Score among the countries in the emerging markets has been at risk. Magni will be watching to see if these most recent events are merely a pause in the series of crises or, perhaps, the first halting steps toward moving forward in a constructive manner.

Caught Between a Trade Rock and a Hard Place for Chinese Reform

  • The United States and China recently concluded talks as part of the Comprehensive Economic Dialogue on trade and security. The meetings concluded the 100-day period of negotiations launched in April by President Trump and Chinese President Xi Jinping. The two sides agreed to work cooperatively to reduce China’s large trade surplus with the United States, but there were no concrete deliverables such as new openings in the Chinese market for U.S. companies. In another sign of deep differences, the plan for a one-year framework for further negotiations that was expected as part of this round of negotiations was not established. Further highlighting the discord, a joint statement was not made and scheduled press conferences were cancelled. The lack of progress makes it more likely that Trump could forge ahead with unilateral steel tariffs or quotas based on a national security review, which would in turn invite retaliatory measures with unpredictable consequences on trade and the global economy.
  • Separately, China last month had its twice a decade National Financial Work Conference to develop policy guidance on financial regulation in anticipation of the 19th Communist Party Congress to be held later this year. The meeting stressed the importance of ensuring financial stability and supporting the real economy with financial reform, with the opening of the economy appearing to take a back seat.
  • Implications: While the stakes in the trade discussions are high for both countries, China is more dependent on trade and hence at greater risk. That said, trade wars have been shown to be very detrimental to many countries and often hard to contain. The upcoming congress may be further bad news as necessary reforms and market opening will be replaced by expedient measures designed to buy time. Such actions tend to make asset and debt bubbles larger, along with causing sharper and more painful events when the bubbles eventually burst. China’s two-year run of meaningful upgrades by Magni may be over.

One Can Hope That This Time is the Charm

  • The International Monetary Fund has agreed to participate in the European Union’s bailout of Greece, though with important caveats. The agreement followed the EU creditors decision to lend the country 8.5 billion euros, which will allow Greece to pay back its loans coming due in July. Germany is eager to have the IMF’s participation to help inoculate it from criticism in the run-up to this year’s elections. However, the impasse on debt relief for Greece that has so far prevented the IMF from extending any new loans has not been finally resolved. The IMF agreed to conditionally extend a new one-year loan, but there will not be any funds distributed until the EU delivers a credible plan to ensure debt sustainability. The IMF is also requiring Greece to continue implementation of structural reforms, and in order to compel compliance the latest bailout also includes an overall cap of around 320 billion euros on the debt-stock Greece can hold. Greece has recently had a successful return to the bond markets, but the cap will have the effect of limiting new debt largely to the refinancing of existing bonds.
  • Implications: While in the short-term the agreement has boosted confidence, follow-through on a realistic plan to allow Greece to reduce its debt burden will be necessary for Greece to exit its ongoing cycle of bailouts. Perhaps the IMF will be a successful catalyst to achieve the required reforms and debt restructuring. If so, the risk discount on major parts of Europe, and especially Greece, could be reduced and make Europe a buying opportunity.

Groundhog Day in Brazil

  • In one of the most explosive developments from the ongoing Brazilian corruption scandals, former president Lula da Silva has been convicted and sentenced to 10 years in prison for accepting bribes. Prosecutors said the bribes were spent to refurbish a beach apartment for Lula in return for his help winning contracts with state oil company Petroleo Brasileiro. Lula continues to maintain his innocence and has vowed to appeal his conviction. The appeals court is expected to take at least eight months to rule. In the meantime, presidential elections will be held next year and the former president has been considered a front-runner to again assume the presidency. If his conviction is upheld, he would be barred from office for 19 years, but he is expected to be allowed to remain free and to continue his campaign while the conviction is under appeal. He is also facing four additional corruption charges that have yet to go to trial. The verdict against the former president has further polarized Brazilian society and the prospect of him being excluded from the presidential election has shaken up the race. The turmoil in the political establishment from the numerous corruption scandals makes it more likely that an outsider candidate could emerge.
  • Implications: This commentary has covered many aspects of the Brazilian corruption. These latest developments reinforce the perspective that the corruption is deep seated and will not be addressed quickly.