July 2020

Country Ranking Trends

  • Magni recently completed a review of South Korea’s regulatory environment. Both banking and insurance supervision improved. In particular, the opaqueness enveloping insurance regulation has dissipated. The resulting upgrades moved South Korea ahead of countries in the developed market, such as Hong Kong and Austria.

Wirecard Looks Like Germany’s Enron

  • The German payments processor, Wirecard AG, once one of the fastest-growing European fintech companies, collapsed into insolvency after an elaborate multi-year accounting fraud came to light. Before its downfall, the firm had replaced Commerzbank on Germany’s benchmark DAX index, and at one point its market value exceeded that of Deutsche Bank. The revelation that auditors failed to locate €1.9 billion of the company’s cash was the event that precipitated the firm’s failure; however, there had been allegations against the company going back over a decade. The episode raised questions about whether Germany’s financial regulator, the Federal Financial Supervisory Authority (BaFin), could have acted sooner. On several occasions BaFin received detailed warnings about deceptive financial practices, but repeatedly declined to pursue the allegations. BaFin instead launched investigations against the accusers charging that they were engaged in market manipulation. In response to the apparent regulatory shortfall, the German finance ministry has announced a review of BaFin’s powers and mission, and the Bundesbank president has called for stronger auditing and accounting rules.
  • Implications: The collapse of this company is somewhat reminiscent of the 2001 collapse of Enron in the U.S. In the subsequent years, legislation was passed in the U.S. strengthening the accounting and auditing procedures that enabled the deception. Germany likely will go through some similar process. For the short term, Magni will be watching for specific issues to justify a downgrade of the country, though any downgrade(s) likely would be modest given the country’s many strengths. For the long term, whatever the German equivalent of Sarbanes-Oxley might be, it could lead to future upgrades.

Is the European Union Rescue Package the Beginning of Something Bigger?

  • Confronting the economic fallout from the global pandemic, the 27 leaders of the European Union agreed to a landmark stimulus plan in order to cushion their economies against what is expected to be a recession worse than anything since World War II. After difficult negotiations the leaders agreed to a €750 billion rescue package to be spent over several years. For the first time the plan calls for selling collective debt issued by the European Commission and giving much of the money as grants, not loans. Historically more creditworthy EU nations (sometimes called “frugals”) resisted underwriting loans, but there was a realization that a worse option was facing a subsequent currency crisis in the event a highly indebted country, such as Italy, defaulted on service of its debt. In a concession to the “frugals”, any country that wishes to use the new funds will need to submit a plan for how it intends to spend the money. In addition, the €500 billion that was proposed in the form of grants was pared back to €390 billion, with €360 billion earmarked for loans. The plan now heads to the European Parliament for ratification and then subsequently to member state legislatures.
  • Implications: In May, the Magni commentary discussed the potentially positive implications of issuing common debt. Germany has now allowed the European Union to travel down the road of greater fiscal union. Many additional decisions will confront the union, and these decisions will determine whether the issuance of common debt will be the beginning of a stronger union or, as Germany has traditionally feared, a process of Germany financing the debts of countries that it views as spendthrifts. More than 30 years have demonstrated that major EU decisions are traumatic with extensive negotiations. Does the union have the leadership to navigate these complex issues?

Poland’s Missed Opportunity

  • Poland’s incumbent President Andrzej Duda narrowly won reelection, defeating Rafal Trzaskowski in the second round of voting. The election was closely watched because Trzaskowski offered a break from the populist policies pursued by Duda and his allies in the ruling Law and Justice (PiS) party. Trzaskowski, the mayor of Warsaw, and leader of the main opposition party, Civic Platform (PO), advocated for better relations with the European Union, which has often clashed with Duda’s government over issues such as judicial independence. He also called for more tolerance; in contrast, Duda described gay and transgender rights as an ideology that was worse than communism. The election pointed to a deepening urban-rural divide in the country, with Duda dominating in the conservative rural eastern part of the country and with older voters. Trzaskowski won handily among young voters and in the largest metropolitan areas. The Civic Platform party has appealed to the Supreme Court to invalidate the election, citing tens of thousands of votes from abroad potentially left uncounted, among other issues. The Supreme Court has 21 days to review all election protests, but it is not expected that the results will be changed.
  • Implications: Duda is one of the many populists in leadership positions around the world. Populists tend to be corrosive to good governance. The success of the country following the collapse of the Soviet Union is long forgotten. Instead of being viewed as the first former Warsaw Pact country to be considered for upgrade to the developed markets, Poland falls further behind leader countries in the emerging markets, while Thailand has an opportunity to overtake it.

South Africa and the Pandemic – A Window into the Future?

  • South Africa had been praised for its early efforts to control the spread of Covid-19. In March, South Africa imposed one of the earliest and most sweeping lockdowns in the world. The measures worked in controlling infections, but the lockdown was economically devastating for a country that was already in recession before the pandemic hit. In June, owing to the hardships caused in a largely poor and informal economy, President Ramaphosa reopened large parts of the economy despite rising infections. The subsequent surge in cases has brought South Africa to the fifth-highest total of Covid-19 infections in the world. The real number of infections is likely to be much higher. A recent study estimated that there were more than 10,000 excess deaths between May and July compared with what would have been expected based on historical data. In response, the government has re-imposed a ban on alcohol and instituted a nighttime curfew. Schools are also closing for four weeks after several thousand students and teachers tested positive. The WHO has warned that the surging numbers in South Africa, which had an earlier start to its outbreak than other African countries, could be a precursor for similar outbreaks across the continent.
  • Implications: Countries with extensive poverty, weak healthcare systems, and underdeveloped systems for reporting information likely will face even greater challenges in fighting the pandemic than more developed countries. South Africa is better positioned than many countries in the world, and it is struggling. Early and plentiful testing, good information systems, and widespread adoption of good hygiene practices by the citizenry (e.g., masks, social distancing) are crucial to a good pandemic response. Few countries have done this well. The economic impact of not responding well is significant. We well could see rising unrest as the poor and working poor are impacted the most by both the medical toll and economic impact.