GRI’s Weekly Risk Outlook

GRI’s Weekly Risk Outlook

Sri Lanka holds early elections. Bank of England to decide on monetary policy. U.S. to release federal reserve meeting minutes and new employment data. Greek elections threaten financial markets. Deflation pressures China’s central bank. All in this week’s GRI Weekly Risk Outlook. 

Sri Lankan elections: risks amid momentum for change

Sri Lanka is set to hold early presidential elections on 8 January 2015. For the first time in over a decade, the polls are expected to be heavily contested due to a consolidated opposition coalition and an incumbent President eager to stay in power.

Although presidential elections were due to take place in 2017, President Mahinda Rajapaksa took the country by surprise when he called for early elections last November. Mr. Rajapaksa believed this would ensure his third re-election at a time when the opposition groups were thought to be deeply divided. This move however backfired.

Reacting promptly to Mr. Rajapaksa’s decision, the opposition coalition designated a heavyweight presidential candidate – Mr. Maithripala Sirisena – a former minister in Rajapaksa’s cabinet and Secretary General of the Sri Lanka Freedom Party (SLFP). Largely popular within the Sinhala Buddhist majority, he has led a wave of defections by prominent political figures disgruntled by the President’s authoritarian grip and nepotistic practices. With the support of 40 political parties and groups – including the main opposition United National Party – the electoral prospects for Mr. Rajapaksa have waned, particularly in light of the disappointing results in a series of recent provincial polls.

Running on a platform to implement constitutional reforms to limit executive power and restore independent oversight bodies, fight corruption and improve energy security for Sri Lankans exasperated with the rising cost of living, Mr. Sirisena has boosted his appeal vis-à-vis the electorate. Most importantly, with the backing of the minority Muslim and Tamil parties – whose supporters constitute a quarter of the total electorate – the opposition leader has gained great momentum in the run up to the election, with a non-SLFP victory a real possibility for the first time in over a decade.

However, Mr. Rajapaksa’s stronghold over state resources (media, police, judiciary) and reputation for doing whatever it takes to stay in power raises the prospects of electoral malpractices and ensuing violence. There are fears that the government may use the radical Buddhist group Bodu Bala Sena to generate violent incidents against Muslim communities so as to incite a backlash destined to consolidate the government’s Sinhala electoral base. Moreover, with the north-eastern provinces under tight military control, armed forces could be used to restrict voting through intimidation of Tamil and Muslim voters.

In a restrictive environment imposed by the governing authorities, the scope for action by civil society and minority groups is limited and the risks of electoral violence will be high if the President sees his electoral fortunes deteriorating. Amid the greatest risks are the potential for punitive repercussions in the event that Mr. Sirisena wins the vote. Indeed, the President can resort to the politically compliant Supreme Court to invalidate the result or use other extra-constitutional means – such as use of force – to retain power.

Given the intensity of the electoral competition, investors should be weary of the business operating environment in the coming months, particularly in the expectation of highly contested results, campaigning intimidation and post-electoral violence.

Bank of England: rate hike not likely till mid-2015

On 8 January, the Bank of England’s (BOE) Monetary Policy Committee (MPC) will meet to decide whether to raise the benchmark interest rate from a record-low of 0.5%. With inflation dropping to 1% in November 2014 and average weekly earnings showing a slow but steady rise amid a stable unemployment rate (6%), all eyes are on the BoE to enact a rate hike.

Many surveyed economists are however expecting that an increase in borrowing costs to about 0.75% will not be realized before mid-2015; largely depending on the evolution of wage and inflation trends, as well as the timing of the much-awaited broadening of quantitative easing in the Eurozone.

With this in mind, the tone adopted by the BoE has been one of caution. In spite of the latest MPC minutes showing that two members of the MPC had voted for a rate rise back in November, the majority of the MPC members are calling for rates to remain steady until more promising evidence on wage growth comes to the fore. Moreover, many former MPC members have stated that the BoE should not raise rates until inflation forecasts exceed the target of 2%. In recent comments, the BoE’s deputy governor stated that although economic recovery has remained strong, emerging evidence pointing to a slow U.K. GDP growth rate and deteriorating prospects for the global economy suggest the BoE should maintain its current degree of monetary stimulus.

United States: Watch for news on rates and employment

This week, U.S. market attention will be on the publication of the minutes from the FOMC December meeting (Wednesday January, 7th) and the December employment report (Friday January, 9th).

Regarding the former, expectations are that the minutes will reflect the cautious tone that emanated from the last Fed policy meeting of 2014 – one in which we do not foresee rate hikes for “at least the next couple of meetings”, as stated by Chairwoman Yellen in her December press conference. As a result, we should see no surprises in relation to forward guidance other than the reflection that most FOMC members are favoring a move towards more “flexible guidance” – with dovish concerns trumped by the FOMC’s clarification that they view the new form of guidance as consistent with the old one. Although hawks of the likes of Mr. Fisher and Mr. Plosser will still be advocating for a rate hike in early 2015, particularly in view of the Fed’s data-dependence policy, we should, at the least, expect the upcoming minutes to shed some further light on the timing of the rate lift-off.

As to the employment data, the expectation is that the released figures will be a welcome result for the Fed and the U.S. economy as a whole. Against the backdrop of impressive 2014 employment growth (with an estimated 2.65 million workers added to the payrolls YTD – the strongest job creation year since 1988), estimates vary little and the general consensus is that the data will show around 275,000 jobs were created last December. As a result, the employment rate should continue to fall to about 5.7%, engendering stronger calls for the Fed to revise its forward guidance in light of these favorable data results.

Greece: market stress over early elections

Following the incumbent government’s failure to win the 180 parliamentary votes required to secure the election of Stavros Dimas in a third and final round of voting to elect a head of state, Greece is set to hold early general elections at the end of January. With the dissolution of parliament, recent opinion polls point to the fact that no single party will be able to secure an outright parliamentary majority.

While still ahead of New Democracy, opposition party Syriza’s lead has narrowed, according to voter surveys. Nonetheless, these surveys suggest that a Syriza-led coalition could still win about 33% of the votes, more than the estimated 29% for New Democracy. With intensifying market stress emanating from political uncertainty in Greece, a potential Syriza victory does not bode well for investor confidence and growth sentiment in 2015.

Lacking any sort of government experience and campaigning on an anti-austerity platform, fears have been raised over the prospects of a potential Greek exit from the euro as the February deadline for the two-month extension of the country’s bailout programme looms on the horizon. With plans to implement an ambitious social spending plan, a would-be Syriza government would no doubt have to resort to additional borrowing to fund its populist promises, in spite of dubious counter reassurances by leader Alexis Tsipras. This would push Greece’s borrowing costs upwards, thereby deepening its repayment quandaries and generating widespread creditor concern.

With the German finance minister reiterating that any new Greek government would have to honour its debt obligations, the prospects that a potential Syriza-led coalition government will seek to defer its financial commitments will no doubt generate further market stress and undermine the prospects of economic recovery in Greece.

China: dovish pressures on PBoC

Deflationary pressures are mounting on the Chinese economy. With tumbling producer and commodity prices, the Chinese December CPI – to be published either late this week or the next – is expected to remain at a low 1.5% y/y, a modest uptick from the 1.4% figure of last November. PPI is also projected to fall further into negative territory to -3.1% y/y, from -2.7% in November.

With inflation at 2 percentage points below the 3.5% target, the People’s Bank of China (PBoC) will likely consider the possibility of easing monetary policy further, especially against the backdrop of falling housing and energy prices and the need to stimulate sluggish industrial and money supply growth.

The GRI Weekly Risk Outlook (WRO) provides analytical foresight on the economic consequences of upcoming political developments. Covering a number of future occurrences across the globe, the WRO presents a series of potential upside/downside risks, shedding light on how political decisions impact economic outcomes.

The WRO is written by GRI analyst Jose Luengo-Cabrera

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