Summary of CEPII/CAS meeting: Globalisation and Financial Crises

Stephane Colliac has assisted to a comprehensive seminar organized by the French government agency Centre d’Analyse Stratégique and the French think-tank CEPII on issues related to the ongoing financial crisis. As our customers are aware, TAC was among the first institutions to note that the problem was not only related to the subprime segment of US mortgage credits (the problems with so-called NINJA borrowers: those with No Income, No Jobs, or Assets), but to a much broader issue related to the endogenous development of the financial sector over the past ten years, including the securitization process and the growing use of derivative instruments in complex financial assets.

India, a new Asian giant

Thierry Apoteker was the moderator of a meeting organized by Premier Cercle in conjunction with the Wall Street Journal Europe on April 17, 2007. The meeting was an occasion to hear and discuss about India's current situation, background, prospect and business opportunities from a very diverse and captivating set of speakers from academia (Mr. Rajesh Sharma, from Sciences Po Paris), the business community (Mr. Bertrand Collomb, Chairman of Lafarge made the introductory speech, and there were two roundtables with business representatives and lawyers), and the political arena (conclusion by the Ambassador of India in France). Thierry has summarized his perception of the discussions and presentation in a short note, where he insists on the complex but irresistible attraction of India for European companies.

A short comparison of recent EU-US trade developments with China

In the context of TAC’s recent work for the European Commission, we investigated the EU and US trade developments with China. We observed an on-going “re-balancing” of China’s overall trade relationships, with a visible acceleration in China’s imports from the US, with a much faster dynamics than from the EU. Conversely, imports from China, on the other hand, were growing at roughly the same pace for the EU and the US. The trade balance has therefore been deteriorating much more rapidly for the EU than for the US, with the most intense competition for EU exports concerning key industries like cars, electronic components and some equipment goods.

Re-assessing the meaning of "Made in China"

In the context of TAC's current work for the European Commission in China, we have assessed the "real" meaning of exports from China: indeed, the growing share of China in total world trade has triggered alarm bells in many policy makers’ minds, and questions about how to accommodate such a rapidly emerging trading giant in the current world trade structure are coming to the fore of international debates. The research shows that the import content of China’s export is extremely high, that most of the gains in market shares are due to foreign invested companies operating in China, and that China’s gains in market shares have been mostly at the expense of other Asian suppliers.

Press Presentation by TAC on emerging markets' potential and industrial countries' portfolio of emerging partners

Early in March 2006, TAC organised a Press Meeting in Paris to present results of a recent research on developing countries' "business potential", and the analyses that such a research induced on some industrial countries portfolio of exposure to emerging markets. Combining risks, business potentials and structures of individual countries' exports (France, Germany, UK, Italy, Sweden, USA and Japan) for a set of 49 developing countries, we showed that France's unfavourable export performances were much more related to a poor geographic allocation than to a problem in sector or product specialisation.

March 2006 - Comparative evolution of China’s market shares for shoe products during 1998-2004

The past months have been marked by increasing trade tensions about China’s footwear exports, with on-going discussions about possible dumping of Chinese goods in the European market. It is not in the scope of this research to investigate into this precise issues, but it seemed useful to put the current discussions in a broader and medium-term background, by looking at the past export development in Chinese footwear exports and the relative place of China as a suppliers to major markets.

The analysis is done by using Comtrade data at a 2- and 4-digit level of HS classification. The approach is in two steps: the first one is based on China’s reported exports in order to identify the key markets of destination, notwithstanding the fact that China’s figures are widely below what is reported as Chinese imports by most importing countries. The second step is an examination of the major markets’ imports of footwear from all supplying countries in order to identify countries that are able to keep a satisfactory development in such exports despite the growing role of China, and conversely the countries that have significantly lost market shares to the benefit of China.

Taken from China’s statistics as reported in Comtrade, total exports of footwear increased by 63% (in euros) between 1998 and 2004 to reach EUR 12.2 bn. The US, the EU and Japan are the largest markets, accounting for 59% of the total Chinese exports, and probably more if exports registered to other destinations but still arriving in those markets were included. Within these three key markets, the EU has registered the fastest increase over this period, +97% compared to +24% for the US and +48% for Japan.

Footwear, gaiters and the like, parts thereof
[HS1996 code 64]

Source: ComTrade

Within footwear (HS64), three products at the 4-digit level account for 89% of the total: 6402 (Footwear nes, with outer sole, upper rubber or plastic), 6403 (Footwear with uppers of leather) and 6404 (Footwear with uppers of textile materials). The details of China’s exports to the main markets for these three categories are provided in the tables below. In each of them, the EU is the second largest importer after the US, and the one for which the highest growth rates are observed within the 3 largest markets, ranging from +75% for products 6402 to 100% for 6403 and 213% for 6404, while the corresponding figures for total Chinese exports, and for exports to the US, are, respectively, 71% and 2% for 6402, 54% and 31% for 6403, and 70% and 63% for 6404:

Footwear nes, with outer sole, upper rubber or plastic
[HS1996 code 6402]

Source: ComTrade

Footwear with uppers of leather
[HS1996 code 6403]

Source: ComTrade

Footwear with uppers of textile materials
[HS1996 code 6404]

Source: ComTrade

The second aspect of the analysis is based on the examination of the 3 largest markets’ main suppliers during the same period. The table below provides the structure of footwear imports by the US, the EU and Japan since 1998. The observation of the changes in footwear trade during this period allows for the following comments:

• China is the largest supplier to the three key markets, with a massive difference with the second supplier in the US market, more moderate gaps for the other two markets (EU and Japan).In all three markets, the increase in imports from China between 1998 and 2004 has been more than double the overall trend in imports.

• The growth rate indeed has been much faster for EU imports of footwear from China than for Japanese or American imports from China, but the total increase in EU imports of footwear has also been more rapid than in the two other markets (respectively +34%.5, +8.7% and +20.1% for the EU, the US and Japan)

• In all three markets, there is a limited number of other suppliers that achieve comparable or even higher increases than China: Vietnam and Romania for the US, Vietnam, Romania, Slovakia for the EU, Vietnam, Cambodia, Thailand, Myanmar, Bangladesh, Romania and India for Japan.

• Suppliers that are crowded out are quite different according to the observed market: for the US, it is primarily other Asian countries (Thailand, Korea, Indonesia), Mexico and Canada (despite the NAFTA), and the EU15 that registered a contraction in the value of footwear imports; in the case of Japan, Korea and the US are the major losers of market share, but the EU15 increase has been quite modest, albeit positive (+4.1%).On the EU market, it is also other Asian countries (Thailand, Indonesia, Hong Kong) and a couple of European countries (Hungary, Croatia, Poland) that have seen negative growth during this period.

Footwear, gaiters and the like, parts thereof
[HS1996 code 64]

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Jan. 2006 - Reading between the lines of China's new GDP statistics

The fresh changes in China’s gross domestic product statistics have not made as much noise as what we could have awaited for. Maybe are people simply lost and somewhat resigned with the Chinese statistical apparel. Whatever the reason of this cautiousness, we wanted to make a summary and give some of our feelings, both qualitative and quantitative, on these changes.

Indeed, on December 20, 2005, the National Bureau of Statistics (NBS) has made a first move in answering critics about the reliability and consistency of Chinese economic statistics by raising China’s 2004 overall GDP by 16.8% to RMB 15,988 bn (USD 1,973 bn). Taking into account these new data and incorporating the recent 2005 figures, China’s RMB 18,232 bn (USD 2,230 bn) economy reaches 5% of the world economy and overtakes Italy (in 2004), France (in 2005) and the U.K. (2005) to become the 4th largest economy worldwide, behind the U.S., Japan and Germany, from a 7th rank in 2004 before this recent revision. The latter, based on the results of the new National Economic Census, translates a higher private and services sectors growth and contribution (the value of the latter has been raised by 48.7% to 40.7% of GDP for 2004, while the private sector should now represent close to two-thirds of GDP) and a more balanced breakdown from the demand side. The inclusion of non export-turned and few capital intensive sectors indeed implies a higher role for domestic consumption in global growth.

Chart 1. Composition of China’s GDP in 2004
Original and revised breakdown

Based on this global re-estimation, the Chinese statistical authorities provided adjusted GDP growth rates over the 1979-2004 period 3 weeks later (on January 10, 2006). Since the former 1992 Census led to a revision of historical data from 1978 to 1992, one should have awaited a revision of data from 1993 to 2004. However, in this case, the 16.8% upward-revision of GDP would have implied an average +1.4 percentage points adjustment in annual GDP growth rate (putting 2004 growth close to 11%). Chinese authorities have then proceeded differently… and the average GDP growth for this larger period was revised to 9.6% against 9.4% previously. Changes for the most recent years are however more significant, with an average +0.5 percentage points revision over 1993-2004.

Table 1. GDP growth rates, 1993-2004
Original and revised figures

Source: National Bureau of Statistics

However, some statistical incoherencies remain - the new 9.6% annual average growth rate over 1979-2004, against 9.4% previously, leads to a cumulative increase of less than 5% only in total GDP! – and the new figures are undoubtedly still far from accurate. Nevertheless, despite lingering questions, such a revision is an incontestable improvement, but quite insufficient to fundamentally change our assessment on China’s main economic issues:

• The relative levels of investment and credits (as a percentage of GDP) remain exceptionally too high. Based on the former end-2004 data, they respectively accounted for 45% and 167% of GDP. Taking into account the more recent estimates on the 2005 growth rates of each of these variables and, for investment, retaining the extreme assumption that the global 16.8% increase in GDP does not reflect into higher investment spending, we indeed obtain still worrying figures. On the one hand, growth in credits provided by the banking sector has decelerated to around 10% year-on-year in 2005H1, i.e. around the same rate than GDP (which is estimated to have grown by 9.9% over the whole past year). Therefore, banking credits still amount to 142% of GDP, highlighting a huge leverage effect, which reinforce micro vulnerabilities as the most unfavorable component of China’s country risk. On the other hand, based on a growth rate of investment around 25% in 2005, the latter would still account for… 44% of GDP at end-2005, i.e. an almost similar level to the end-2004 one and an all-time record!

Table 2. Still worrying weights of investment and domestic credits
In % of GDP

Sources: World Bank, T-A-C estimates

• Our assessment about the issues China will face in the next couples of years is therefore intact (TAC has developed a comprehensive range of medium-term projection tools on China, that are available for in-depth scenario construction and strategic advisory services – interested customers are welcome to contact us at info@tac-financial.com). In one sense, this GDP revision further highlights how the Chinese authorities use economic information as a political instrument: the Census results are not surprising since most developing countries have a gray economy, mainly in the services, at around 20% of GDP; but most of them also decide not to register it in the national accounts since it is difficult to assess its yearly evolutions; in that sense, this revision was once again a “Chinese exception”… and the best way to somewhat calm down investors’ fears before their Christmas break!

Opacity is then more than ever the keyword to characterize the Chinese statistics. To illustrate this, we made a simple estimate of GDP growth on a panel of large developing countries between 1970 and 2004. Our model includes an individual constant for each country, and GDP growth is explained by growth rates in consumption of two physical items: total primary energy and cement. The inclusion of a specific constant for each country allowed us to improve our model in capturing the Chinese exception. Indeed, only the Chinese individual constant proved statistically significant; furthermore, taken individually, our estimates match very well the long-run GDP growth profiles for all countries… except China. This simply further illustrates how the authorities are acting on statistics to smooth this growth profile, overestimating GDP growth during slowdowns (such as in 1997-1998) or underestimating it during phases of overheating fears (as since a couple of years).

Our model shows an interesting statistical quality (with a 85%+ adjustment coefficient or R², which is particularly high when directly working on growth rates rather than on indices or volume). It reveals that, other things being equal, a 1 percentage point (p.p.) increase in primary energy consumption implies a 0.19 p.p. increase in GDP growth, while a 1 p.p. rise in cement consumption induces a 0.26 p.p. in the GDP growth rate. In other words, given the quality of our econometric model, monitoring the pace of expansion of these two variables allows to nicely assess / anticipate the dynamics of GDP in emerging countries.

Then, betting that our model is true and that official statistics are false, next page is presented what GDP growth may have really been in China in the past since 1995. It first depicts a stronger impact of the Asian crisis than what official statistics indicate, with GDP growth having fallen to as low as 4-5% in 1998. Moreover, although GDP growth may have been closer to 11% than 10% in 2005, it has strongly decelerated from the 2002-2003 13-14% levels, which points to an earlier true “overheating” with compared with foreign investors and analysts’ fears, as clearly (and timely) predicted by the path of the country in our Cyclical Balance. The latter so far indicates further but still limited deceleration in GDP growth this year that, overall, should remain around 10% this year, provided no accident occurs. A simple extrapolation of the “true” cyclical profile of Chinese growth would also tend to indicate that this year or next year China should reach a (limited) trough, before a further re-acceleration and certainly very high true growth rates in the following years. It also points out that the magnitude of true cycles has globally declined (not at a point of what the authorities want to signal), and that the under-estimation of growth rates over the recent years was not as strong as what some analyst declare.

Chart 2. The truth on GDP growth in China, 1995-2005
Actual and estimated figures

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Nov. 2005 - China in the World Economy: Internal and International Challenges
A personal note on the 5th International IDREC Conference by Bing Hang, economist intern at TAC

The 5th international IDREC conference dealing with the Chinese economy took place in Clermont Ferrand on October 20th and 21st, 2005, organized by the CERDI (Centre d’Etudes et de Recherches sur le Développement International). The speakers were numerous and came from the four corners of the world. Among them, we can quote Mr. Gang FAN (Chinese Academy of Science, Beijing University and NERI, China), Mr. Wing Thye WOO (University of California, Davis, USA), Mrs. Elize BREZIS (Azieli Center for Economic Policy, Bar-Ilan University, Israel), Mrs. Françoise LEMOINE (CEPII, France), Mr. Gilbert ETIENNE (Graduate Institute of International Studies, Geneva, Switzerland), who are all considered today as the pre-eminent “China specialists”. The focus of this international conference was the discussions about the challenges confronting the development of China, both internal and international.

From a practical perspective, the reception and welcome by IDREC’s members was impressive, from organization to practical occasions for networking and informal exchanges. IDREC’s director, Professor Patrick GUILLAUMONT, even tried to say some words in Chinese during the gala dinner at the Batisse Castle on Thursday evening, providing both enjoyment and cheerfulness to the whole audience!

Concerning the content of the Conference, it was equally impressive: about thirty different research papers were presented and discussed (see the program at the end of this note), with many diverse subjects covered, including international trade, labor market, distribution and retail development, financial markets, exchange rate policy, China’s integration in Asia, provincial or regional perspectives, and industrial organization. Several key questions were raised, notably " How China can develop its economy in a context of the globalization while it has such a large catch-up process to accomplish?” or “What is the degree of dependence of China on foreign supplies, notably for raw materials, metals, farm products and energy? How manage this dependence?” or “ Is there a dimension of spatial dependence?” or “What is specific about intra-Asian business development?”… We noticed that the issues of environment, dependency to commodities, financial markets, population aging, were the most often discussed. Conversely, questions related to industrial standards, and risks of protectionism in the West were simply alluded to in the introduction of this 5th international IDREC conference.

I am currently leading a research for TAC within the framework of a Master’s Degree in International Management and Europe-China Exchanges (University of Paris XII) entitled Impact of China on the world markets. This Conference was therefore particularly timely in this research, and several papers drew my attention: in particular, Mrs. Catherine LOCATELLI (CNRS and University of Grenoble) presented her research on The international integration of the Chinese energy industry and the geopolitical consequences, where she explains the current status of China regarding oil consumption and dependency, the different solutions that China can adopt to face its increasing dependency on petroleum and the geopolitical implications. Obviously, no miracle solution was presented, but the main messages included the need for an increasing diversification of sources of supplies, protection and security of supply lines, and increased equity participation of Chinese companies in large energy producers. Another interesting paper was presented by Mr. Scott ROZELLE (University of California – Davis), entitled Agricultural trade liberalization and poverty in China. Mr. ROZELLE insisted on the issue of food security and possible dependence on imported food products, and concluded his presentation with key (and unconventional) remarks, including the positive impact of the current trade liberalization on overall and rural household income in China, the growing weight and influence of China in the WTO and for the current Doha round of negotiations, and the long-term positive impact on other food exporters. In the Thursday afternoon session, Labor Market, Mr. Jean-Baptiste LEHEN (CERDI, University of Clermont Ferrand) presented the impact of the WTO membership on the reform of the pension system: this is an area on which I dwell a lot in my research, where I look at the expected changes in China’s demographic characteristics on a very long period (1820-2030). He discussed four solutions to finance the deficit of pensions, with a preference for an increase of 7% in overall production taxes (see, for reference, charts on China’s recent and future demographic changes at the end of this note). Finally, a very stimulating paper was presented by Mr. Jean-Joseph BOILLOT, financial counselor for South Asia at the French Embassy in India (and previously posted in Hong Kong), on The lessons of 25 years of exceptional changes in trade relations between China and India. Two scenarios are envisaged for the future: one is of two very separate but complementary economic development, with China concentrating more on low value-added activities while India would move more forcefully into higher value addition trade. The other scenario, called Chindia, is based on a much more integrated relationship between the two giant nations with a more intricate (and intra-industry) specialization. Boillot’s conclusion was that any scenario would entail significant, but not unmanageable, adjustment costs for the developed world, with a key point being the ability of western companies to improve their targeting of domestic demands in both India and China.

The rise of China’s power in the economic world is one of the major events of the beginning of 21st century. For the past twenty years, as other Asian countries before her, China has relied heavily on her successful integration in international trade and investment to engineer a successful development and catch-up. Today, China is by far the largest world producer for toys, television sets, shoes, domestic appliances, aluminum and steel. It is also a very large importer of raw materials. This emergence as a world leader in these different industries is based massively on a huge capital accumulation effort and the targeting of world markets, notably through the intensive “use” of foreign direct investment.

As a conclusion, let me quote Mr. Gang FAN's, who is considered as one of the key economic thinker in China and a close advisor to the Chinese leadership, and who summarized six key issues facing China in the near-term:

• To benefit from globalization, China above all has to solve its internal problems such as the excessive use of banking resources and too high leverage;

• Foreign Direct Investments (FDI) is required, but with a stronger selection and a more aggressive targeting of new technologies;

• International trade is vital, but China still needs some protection, less in the field of the technology but more for consumer products;

• Some sort of control on capital movement is fundamental: China needs time for the liberalization of capital, even though developed countries try to push developing countries too rapidly in this area;

• The need for further efforts in education is crucial;

• Finally, it is important that politics avoid populism, and that economic pragmatism remains stronger than ideology.

This very interesting conference has reinforced the validity of the current research undertaken at TAC: the inter-dependence between China’s economic development and prospects on the one hand, and the overall world balances (commodity prices, trade, currencies, …) on the other hand, is probably the single most important question for the whole world outlook during the next 15-25 years. How can China’s “massive” entry into world flows be accommodated by the current world situation and organization, and what are the risks of significant disruptions, which can cause both a derailment of China’s path and significant shocks for the world.

Demographic changes in China: a reminder
Evolution of China’s population pyramid

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Oct. 2005 - Assessing the composition of the Chinese currency basket
An update at the end of October 2005

Early September, we used different econometric techniques to try to estimate the relative weight of the currencies included in the basket that is used as a reference for the exchange rate policy conducted by the People’s Bank of China (PboC). The full paper is available on this page.

During the last weeks of October, we decided to update our quantitative exercise to check on the validity of the first estimation when using a longer period. We are obviously trying to achieve the impossible, since the Chinese policy includes the possibility of a daily adjustment of +/-0.3% of the Chinese Yuan against the USD, an “uncertainty” that makes the estimation of the weights of the different currencies technically unfeasible. However, we notice that the CNY has remained almost flat against the USD since our last estimation (CNY 8.0856 on November 4, against 8.09 early September and 8.11 when the policy change was implemented in July.

We decided therefore that it was useful to look again at our econometric exercises to check whether the addition of six weeks of daily spot rates can bring additional information.

And indeed, it does… We summarize here the major conclusion of this updating exercise:

• The explanation of the three “core” currencies” outside he USD (Euro, Yen and Korean Won) appears to be significantly weaker than in our earlier estimate, with a correlation coefficient (R²) declining from 90% to 55%: bilateral changes of these three currencies against the USD are not sufficient anymore to explain the daily changes of the Chinese currency.

• When adding three “secondary” currencies that were initially included officially in the list indicated by the Chinese authorities, we are able to improve the correlation coefficient back to above 90%: the Singapore dollar, the Thai Baht and the Russian Ruble now appear to be “used” more significantly in the overall currency basket, and their daily fluctuations against the USD play a more important role in understanding the evolution of the CNY.

• Whatever the list of currencies identified or used in the currency basket, the weight of the dollar remains very large, between 60% and 67% of the total basket.

• Finally, we noted that the time-lag between foreign currency changes and the CNY adjustment appear to have increased from one day (which provided the best statistical results in our initial exercise) to about 5 days now, i.e. one week of working days, which now enables to significantly improve the statistical qualities of our econometric relations.

Reminder: list of currencies included in the basket as indicated by the Chinese authorities

The bottom line of our analysis is almost unchanged, i.e.:

• The Chinese authorities are going to move very gradually in their path towards a more flexible exchange rate and towards a more significant appreciation of the CNY.

• The most likely value for the CNY over a one-year time horizon would be close to CNY 7.5 against the USD, in the middle of a larger range of 6.85-7.99.

• The appreciation of the Yuan is still considered by the Chinese authorities as a bargaining instrument in the current international trade debate. The likelihood of the appreciation is fundamentally dependent on successful trade negotiations between China and its main trading partners.

• If the WTO Ministerial meeting in Hong Kong next December results in a more predictable and less risky medium-term trade environment for China, recent remarks by PboC Governor Zhou about the Chinese economy “sufficient flexibility” can be considered as serious announcement of a more rapid appreciation in the first half of next year.

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Sep. 2005 - Assessing the composition of the chinese currency basket

The change in China’s exchange rate regime on July 22, 2005, has been the major and long- awaited / speculated event of this summer. Although details on the mechanics of this new regime and the contents of the CNY basket have been officially released by the PBoC, the weight of each currency in this basket remains a major unknown. Only few specialists have formally tried to assess these weights.

Officially, the main criterion that is used to select anchor currencies is the importance of the current account transactions. Governor Zhou also cited the currency composition of China’s external debt and the origins of FDIs as two important items to be considered as well. Therefore, the officially released list of currencies entering into this basket is the following:

Table 1. RMB official currency basket

TAC’s research team has decided to try to estimate the weights of each currency using three different methods. The first method is to estimate the weights by measuring the relative shares of Chinese trade with his partners. This methodology is consistent with the official message but does not give any answer about the ‘true weights’ empirically observed over the period considered. Consequently, the second method that we decided to use is to estimate these weights on the basis of an econometric model of the relationship between the exchange rates. Finally, we used a refinement of this econometric model by estimating different cointegrating vectors between the main currencies, in order to find the different possible assumptions about the observed weights.

We started this short study on estimating the different weights of the currency basket by taking into account the relative weights of the current account transaction of China and his partners. Focusing on China’s main trade partners (both for exports and imports) in 2004, we find that the USD would represent 33% of the basket, the JPY 30%, the KRW 16%, the EUR 11% and the other currencies around 10%. This simple estimation undoubtedly underweights the share of the USD, since most of the transactions in China’s current and capital accounts are denominated in this currency, whatever the partner country. Therefore, a more refined assessment is needed to provide more realistic measures.

We first simply regressed – using the ordinary least squares (OLS) estimator – an index of the daily exchange rate of the CNY against the U.S. dollar (with spots from July 22, 2005 to September 6, 2005) on indices of daily exchange rates (basis 100 on July 22, 2005, still against the USD) of all the currencies forming the basket presented on table 1. Only the coefficients associated to the EUR, the JPY and the KRW were significantly different from zero. Therefore, a first conclusion is that the daily fluctuations of the yuan are essentially explained by the evolutions of the main currencies and only marginally by secondary currencies.

We made a second regression, including only the previously significant currencies. From this estimation, two very interesting conclusions can be derived:

• The best fit is obtained with a lag of one day. It means that the Chinese authorities take one day to adjust the exchanging rate of the yuan to the fluctuations of these currencies.

• The R² of the estimation is 90%. Apart from the outstanding statistical quality of the regression, it may indicates that the variations of the “secondary” currencies explain only 10% of the daily variations of the yuan.

As all the times series of this group are non-stationary, we were interested in determining whether these series were cointegrated, and in identifying all the possible relations between the currencies (to be able to test different possibilities of currency baskets). We identified two relationships using a Johansen’s cointegration procedure. According to the long-run equilibrium relation considered, the weight of the USD ranges from 62% to 81%. It does not necessarily mean that the weight of the dollar in the currency basket is so high, but that the consequence of the official weights to other currencies is equivalent to an anchor of more than 80% to the dollar (this is a consequence of the cross correlation of the other currencies to the USD).

Graph 1. The following graph shows the actual and fitted values of the USD/CNY

Finally, the table 2 compares the TAC estimated weights of the Chinese currency basket using all the estimation procedures used by the research team. The table indicates that the second cointegrating relationship is the most plausible and consistent with an official ‘reasonable basket’ and with other estimates (with a weight of the U.S. dollar quite higher than what is thought by Morgan Stanley).

Table 2. Trade data, OLS and Johansen Cointegration Procedure

By using the estimated econometric relations presented on table 2 and the Consensus Forecasts available for each of the currencies included in the currency basket on August 2005 for end-August 2006, we are able to forecast different spot exchange rates for the USD/CNY.

Table 3. USD/CNY forecasts for end-August 2006
(spot rate on September 12, 2005: 8.09)

The table 3 presents the different results obtained on the forecasted spot exchange rates and calculated under the extremes and mean average assumptions of the Consensus Forecast. The OLS estimations and the first cointegration relation results are quite similar (with an average USD/CNY around 8.08), but in the case of the second cointegration relation, the estimated USD/CNY is quite higher (around 7.99, i.e. a yearly 1.2% appreciation) and with a wider range of possible values.

However, these estimates of the possible future value of the yuan exchange rate assume that the flexibility created by the new regime is not used at all, i.e. that the Chinese authorities want to keep the CNY stable against their basket of currencies.

But the new regime is indeed a significant and structural change in China’s foreign exchange policy. Even though we are not surprised that China is not using such a flexibility in the short run in order to discourage currency speculation, we also doubt that this will remain so for a very long period of time. Indeed, the need to engineer a gradual but substantial appreciation of the currency appears more and more convincing, because it would allow import prices to decline or stabilize, therefore helping Chinese firms to avoid the continuous compression of operating margins; it would also naturally help the monetary management of the country by progressively limiting the current account surplus and reducing speculative capital flows; it would not dent too much the growth engines of the country but would strongly encourage a substitution of exports by domestic consumption, a key goal of the current Chinese leadership.

In the table below, we illustrate the magnitude of the flexibility introduced by the new regime, by looking at possible values of the USD/CNY exchange rate in one year according to different (arbitrary) assumptions about the use of the ±0.3% daily fluctuations that are authorized.

Table 4. Use of the exchange rate flexibility by the PBoC and possible values of the CNY on a 12-month horizon

If we take the extreme assumption that the CNY would appreciate by a daily 0.15% (half the maximum fluctuation authorized), the yuan value would increase by a massive 33% over one year ; with more plausible assumptions of either a 0.05% per day or 0.3% per week, the CNY would be, in 12 month, somewhere in a large band of 6.77 – 7.12. Taking the average values (computed from the average forecast for the main currencies in the basket against the USD), the range would be a narrower 6.84 – 7.02 against the USD (about 14% appreciation against the value on September 12).

Even though such a message may not be precise enough, this analysis would point towards a very likely range for the CNY of 6.85 – 7.99 in one year time, our preferred bet being right in the middle of the range, i.e. about 7.5 against the USD in September 2006, a 7.3% appreciation compared to the current value. However, everybody should be fully aware that the appreciation of the Yuan is still considered by the Chinese authorities as a bargaining instrument in the current international trade debate. Therefore, the likelihood of the appreciation, as we describe it here, is fundamentally dependent on successful trade negotiations between China and its main trading partners. A much clearer assessment of potential changes in the exchange rate will have thus to wait until the next WTO Ministerial meeting in Hong Kong next December.

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Nov. 2004 - Validation of credit risk models

The Basel Committee on Banking Supervision has been working since 1999 on a revision of the 1998 regulation on capital requirements (Basel II). According to the new regulation to be implemented by the end of 2006, many banks will want to calculate the amount of regulatory capital requirements on the basis of default probabilities estimated from internal credit ratings. But the creation, calibration and validation of a credit risk model raise many technical questions and issues: How to measure the credit risk itself ? How to obtain a realistic migration matrix ? What kind of computational models to use ? How to take into account the business cycles ? How to properly calibrate the correlations in the model ?

The aim of this paper is not to provide answers to all these questions but to try to present and summarize a number of key problems that are currently discussed by researchers and academics working on credit risk...

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Sept. 2004 - Time for Crystal Ball gazing for 2005

Back from holidays, everybody is looking at the 'guess-numbers' for next year. Budget, investment and other planning decision may depend on key assumptions on next year economic performance. TAC is no exception and we have worked intensively on the possible world scenario for 2005.

As most economic observers, we agree that the critical factors are concentrated on the US outlook. Not only is the US the leading engine of world demand and output growth, but the transmission from US financial markets to other centres is so strong that 'contagion' is very likely through financial channels, be they interest rates, exchange rate or equity prices.

We will not disclose here the whole scenario that we have in mind, but we would like to draw the attention on the following “unfolding” of thoughts, supported by a couple of key charts:

1 - A long-term observation of the relationship between the US nominal GDP growth rate and the interest rate on 10-year US Treasury bonds (chart 1) reveals two interesting features: (a) There has been a clear break between the period of accelerating inflation (1960-1980) and the subsequent period of disinflation (1982-2003). In the first period, nominal GDP growth rates are consistently above both short and long-term interest in the US. In one sense, this has been used as a major explanation for the accelerating trend in inflation, and this is what former Fed Chairman Volcker broke with his ‘punitive’ monetary tightening at the beginning of the 80s. Since then, bond yield have stayed close to, but in general slightly higher than, the US nominal GDP growth rate. (b) The very last period (2003 and 1st half of 2004) is therefore clearly a temporary anomaly, where yields are significantly lower than nominal GDP growth. This anomaly is compounded by the peculiar level of short-term rates (here, Fed Funds): we have to go back to the 60s to find such a discrepancy between economic activity and the Fed’s complacency… So, what does this tell for the next couple of quarters? Well, that markets are wrong on at least one variable, among real GDP growth, inflation, short-term rates or bond yield.

2 - A second observation is derived from the past correlation between the yield curve (10-year US treasury bond, minus Fed Fund rates) and the real GDP growth (chart 2). Indeed, the yield curve has been a fairly good predictor of future GDP growth, with a lead-time of about 4 quarters. Based on this observation, the last points would suggest a stabilisation and moderation of US growth rate towards 3% to 3.5% in the second half of 2004 and next year. Here again, two comments are warranted: (a) The 1996-2000 period was a visible exception to that medium-term relationship, with an almost flat yield curve coinciding with high real US economic growth. The explanation may be related to the shift in economic paradigm (the positive side of the Internet / ITC bubble), but also to an exceptional period for commodity prices and therefore for undercurrent inflation pressure. Indeed, the third chart highlights the same ‘exceptional’ period when world GDP growth was not correlated to increases in overall commodity prices, and points towards a return to ‘normality’ in the recent period. (b) If this proves right, then the scenario may be less positive than usually expected, because of the following chain of events: higher world growth during the past 2 years is triggering higher commodity prices and stronger ‘undercurrent’ price pressures; this is in parallel with the expected ‘return to normal’ monetary policy in the US; either the tightening has to be much more significant in the coming quarters, and it would be enough to derail the growth process in the US and lead to sub-potential growth somewhere in 2005H2 (below 3.0%-2.5%); or the Fed reaction is more muted and the yield curve steepens significantly; however, in this scenario, the current sensitivity of the cyclical upswing to such a steepening of the yield curve (i.e. much higher bond yields), through household debt, real estate and mortgage situation, and through corporate investment, would then lead to a definite slow-down, maybe even at the same time that what would trigger a sharper US monetary tightening.

The bottom line is that we consider that the last US recession (2001) was short and rather mild; that only the corporate sector has adjusted its previous financial and investment excesses; that the household sector has not yet initiated this required adjustment, and that US consumers may be therefore more vulnerable to less favourable monetary and interest rate conditions; and that this sensitivity will show its effect when short-term interest rates and long-term bond yield come in line with the levels implied by the current economic conditions.

The US economic growth may well slow down to around 3% in the next few quarters. After two years (2003-04) characterized by a very positive growth-acceleration convergence in most industrialised nations and an exceptionally soft monetary stance, and thus by a very favourable background for developing countries, 2005 will undoubtedly be less supportive, and the downside risks are quite important (US confidence, oil markets, Chinese hard landing, financial markets turbulences….).

Download the paper in PDF format

June 2004 - SME access to finance : issues and challenges

Access to financing resources by small and medium enterprises (SMEs) is a « volatile commodity », both from an academic perspective (from keen interest to outright ignorance) and from an operational point of view: in times of cyclical upswing, providers of finance (mainly banks, but also venture capital) are more than happy to extend indiscriminate loans (almost no price differentiation in lending conditions, and very low spreads over comparable bank loans to large corporates), but when the downswing settles in and SME do require more structural support to muddle through difficult times, the same providers are usually rushing to the exit. Added to the forthcoming Basel II regulation, there is clearly a wide array of key issues, especially when taking into account the key role of SMEs in job creation, and the large share of loans to SMEs in overall bank credit to companies.

Groups of similar companies identified by the Neural Network

Financial profiles of different groups

Academic literature has insisted for quite a long time on the key issue of information asymmetry, through which the difficulty in putting any SME into a statistical category of companies on which quantitative scoring or rating can be applied, leads to an implicit bank rationing towards such SMEs. However, not a large deal of investigation has been made into the issue of SME classification, and the way such classifications influence SMEs access to finance. In most instances, a bank would initially discriminate according to very simple items like industry, size and age of the SME, and then mostly on accounting and financial ratios. It is quite easy to show that such simple classifications have lost most of its meaning in a world where the same industry can imply very different types of activities, and where a same size can have totally opposite meanings, from innovative start-up to standard sub-contractor.

TAC has been engaged in many different studies, academic and operational, on the subject of SMEs (or even Very Small Enterprises, VSE), looking at both the issues and challenges of relevant classification (including by using modern statistical / data analysis tools), and the consequences on access to finance. We are still working on the subject, and are looking for potential partners to develop an innovative and efficient Web-based tool to meet such challenges for SMEs.

Our research work on SME has been largely concentrated on issues of finance and classification. Back in 1996, Thierry Apoteker published an article derived from his academic activities (he was then Associate Professor at Rennes University, in charge of banking economics), trying to highlight the fundamental need for a better understanding of the nature of financial requirements by SMEs (download the article, in French).

More recently, TAC applied these theoretical inputs into more operational analysis, with intensive work on advanced methods of statistical classification / clustering, based on non-linear tools and combining qualitative and quantitative indicators <see a presentation by Sylvain Barthelemy on the use of self organizing maps for such classification exercises>. Our expertise was further enhanced when TAC was selected with a group of prominent French Universities to refine the concept of relevant classification and put it into practice, for the very small enterprises (less than 20 employees), in a study financed by the French Ministry of Economy and Finance (link to the Minsitry’s website where the research is available).

The two charts above provide an illustration of the steps we consider essential for enhancing the relations between providers of finance and SMEs:

• A relevant classification, that allows to identify groups of SME that are more homogenous from the perspective of such financial relations with providers of resources (here, through a neural network and where each colour indicates an area of higher homogeneity among SMEs),

• An ability to compare any SME with the key characteristics of ist “peer group” as identified by the previous classification (here, depicted through web charts where each axis is one key characteristic).

May 2004 - India's elections

What a surprise!

Even the exit polls on the last polling day (May 10th) did not see the Congress victory coming. Remember one month back, the relevant question was the magnitude of the expected BJP’s advance and it’s potential ability to muster a narrower and more pliant coalition.

But the results are here: the world largest exercise in democracy (671 mn electors, of which 384 mn did vote) has sent the BJP-led coalition back in opposition, albeit a powerful one (185 seats, on a total of 545). The pre-electoral alliance led by the Congress (United Progressive Alliance, UPA) won 220 seats, an indisputable lead over the BJP but still 52-seat short of an absolute majority. After short discussions, a range of other parties (so-called Left Front, 59 seats, and other regional parties, 62 seats) decided to offer their outside support to the Congress-led coalition and government, but without any ministerial participation. The combination of UPA and their outside supporters gives the current coalition 341 seats, a seemingly comfortable 69 seats above the absolute majority.

This was not the only surprise: the other one came with the highly visible defeat of two State governments (with State elections being held alongside the national ones), in Andhra Pradesh and in Karnataka, where the ‘reform drive’ was the most explicit, and where the incumbents, allied (at the national level) to the BJP in Andhra Pradesh and to the Congress in Karnataka, were wiped out. This was surprising not only because of the ‘feel good factor’ and ‘India Shining’ that one would expect to be more perceptible in reform-driven states, but also because both governments were not ‘die-hard liberals’ but consistently tried to balance economic and market reforms with social and human development efforts. In the Southern State of Andhra Pradesh, Mr. Naidu, a BJP-ally, champion of reforms and tireless promoter of India to foreign investors, was voted out of power after nearly a decade in office when the state capital of Hyderabad was transformed into one of India’s leading IT centres.

How did it arrive?

Aftermath analysis always seems easier than an accurate ex ante vision…Our own perception of the reasons for such a surprise and the Congress victory can be summarized around three kinds of arguments:

• The Indian electoral process is based on the principle of ‘one past the post gets all’ in each constituency. There is no second round of voting if the leading candidate fails to have the absolute majority. This has very strong implications as minor swings in votes can trigger major shift in parliamentary seats. And this is exactly what happened: the Congress-led alliance saw its voting support increasing from 34.59% in 1999 to 36.45% in 2004, but this was enough to bring about a gain of 66 seats; conversely, the BJP-led alliance saw a decline of 4 points in its global voting share (from 38.45% in 1999 to 34.83% in 2004) that triggered a loss of one third of its deputies to the Lok Sabha (90 seats lost). Finally, all the ‘Other Parties’ mustered a 27.14% vote share (against 24.53% in 1999) allowing a net gain of 24 seats. In this simple arithmetic, a noticeable feature is that the ‘Congress-only’ share of the vote did decline between 1999 and 2004 (from 28.3% to 26.2%), but its spread across the country allowed a net gain of 31 seats, while the ‘BJP-only’ voting share declined by the same magnitude (from 23.7% to 21.5%), but this induced a 42 net loss in parliamentary seats. The important conclusion is that the recent elections have not been a “watershed swing in voters’ preferences”, but a better political organisation and ‘vote mapping’ by the Congress-led alliance.

• Indeed, the Congress mounted a very effective campaign to reach out to voters who felt left behind, stressing the lack of jobs in rural areas, where 70% of the people live, as well as lagging basic infrastructure services, including access to clean water, power and roads. Congress also sought to enter into regional alliances before the elections, enlisting the support of DMK in the Southern State of Tamil Nadu (previously an ally of BJP) and the RJD in Bihar.

• The defeat of the BJP-led coalition after almost 5 years in office can also be interpreted as reflecting the wide divergence between its economic goals and projections, as materialized by the election slogan “India Shining”, and the fact that day-to-day life in most of the rural areas have not been affected by the progresses and reforms, while they have suffered from recurrent drought and a dearth of public investment in basic infrastructures. A somewhat parallel explanation can be found in the geographical pattern of the elections (see map): the so-called “Hindi-belt” (roughly, the States north-east of a Gujarat-to-Andhra Pradesh line dividing the country in two) has clearly lagged behind in terms of economic performances, whereas the southern areas have clearly benefited most; but the core of the BJP traditional support is precisely in this Hindi-belt; as the BJP alliance focuses its campaign on the economic side of its successes, it failed to resonate among its traditional strongholds, while the decision to put aside its more traditional ‘Hindu’ themes has also alienated some of its supporters (as testified by the reaction of the more militant RSS, a backbone of the BJP political organisation and roots, which severely criticised the BJP for not having chosen an electoral platform bringing the Hindu agenda at the centre).

(click on the image to enlarge)

The way forward

• There should be no doubt about the “reform drive” in India: the victory of the Congress will put many interrogation marks on the pace and the precise modalities of the reform process, but the process itself will be continued and carried forward. A clear signal of such a development has been sent with the formation of the Government, the Singh-Chidambaram duo ensuring both a deep understanding of the key economic issues, and a strong willingness to continue the required changes to steer India’s path on a sustainable high growth pattern. The key wording now will be ‘reform with an attention to the rural and the poor’. Conversely, some visible elements of the previous government programme will be put on the shelf for the time being: privatisation of profit-making State enterprises, control of the banking sector and openness to foreign entry. It is however relevant today to ask whether India’s policy makers do have to choose between a very fast but more unequal, or a not-so-fast but better spread, economic development.

• Despite the very strong confidence in the pursuit of reforms, it should also be clear that the political strength of the current coalition is low: the existence of a non-participatory support by a range of very diverse parties (communists, even though they are much more reformist on the ground that what their manifestos tell, regional parties) mechanically implies a need for a permanent compromise. Such efforts may rapidly both exhaust the political leadership and provoke a popular discontentment. The fact that the Congress has only 145 seats (on a total of 545) while the BJP has 138, combined to Indian tradition of smaller parties switching alliances when they feel it can be rewarding for them, would suggest that the stability of the coalition will prove less convincing than the initial word of Mrs Sonia Gandhi, when explaining the early bickering about ministerial posts. If we had to make a bet, we would think that the coalition as it is now would not survive more than two years in office.

• The nomination of Dr. M. Singh to head the government has calmed financial markets; the various cabinet portfolios have been attributed: the Congress has retained the key portfolios of Home, Finance, Defence and External Affairs and the draft of the Common Minimum Program (CMP) has been presented. The salient features of this initial programme include: a stated commitment to foreign direct and portfolio investments coupled with ‘safeguards’ for small players, an increase in infrastructure spending through public-private partnerships, a more targeted and efficient public spending structure with a focus on education and health, coupled with an overall increase in the fiscal intake and a reduction of the Central Government budget deficit, and a case-by-case approach to privatisation.

September 2003 - Cancun, WTO's swan song ?

Over the past few years, TAC has undertaken significant studies and research projects dealing directly or indirectly with the current issues in international trade and investment. Just prior to the WTO Ministerial Meeting in Cancun, TAC economists shared their views with the French Press, expressing our worries about the weaknesses faced by the institutions and what it stands for. In particular, we insisted on the conditional relationship between trade and development, on the negative impact of the proliferation of bilateral trade agreements, and on the many political issues now at stake within trade negotiations.

• Click here to download the slides that we used for the Press Conference.

• A more academic presentation of the current ‘economist’ thinking about trade liberalisation and growth is also available here. This paper was presented at the 7th International Congress of ISINI (www.isini.org ), in Lille on August 21st , 2003.

February 2003 - Situation and perspective for Iraq and the world : a tentative of clarification

The world appears to be suspended to the possible next step in dealing with the Iraqi situation. The arguments for engaging military actions have been put forward forcefully by the United States, while both public opinion and a large number of other countries have expressed themselves in favour of exploring all alternative ‘no-war’ options. The arguments exchanged over the issue have been mixed with a heavy dose of preconception, erroneous views and political calculations. But because the discussion involves a great number of very uncertain or unknown variables, the understanding of the stakes and possible consequences has probably been blurred. While recognizing that TAC does not have any specific or insider information that our customers do not have also, we would like to propose an ‘analytical grid’ for reading the current situation and the likely next steps.

[ Click here to download the PDF file ]

February 2002 - Argentina

Now that the crisis has erupted in Argentina, it looks like if everybody has announced it before hand. However, if we assume that any corporate or investment decision needs at least 12 months advance warning, then the proper signals should have been available at least in the fourth quarter of 2000. The following chart is illustrating that within different agencies, almost none of them did show a "crisis signal" until the summer or the end of 2001. Even the much talked-about predictive ability of the market to announce difficulties is not evident when looking at Argentina's spreads on sovereign bonds. Conversely, we are very proud that our RiskMonitor system was able to deliver the right signals in March 2000 (with our standard 8-quarter horizon), and it comforts us in asserting that the non-linear system that we are using has a superior predictive ability and is more efficient in advance corporate and banking planning.

• (1) - TAC's RiskMonitor Ratings. These Ratings are the most comprehensive quantitative measures of country risk that are computed through the RiskMonitor non-linear methodology. Four different categories of risk and a crisis signal are defined, corresponding to different combinations of the five Fundamental Balances : A (the best rating), B, C and D (the worst). K is the crisis signal using RiskMonitor Ratings notation. If you need more information about RiskMonitor click here.

• (2) - Standard & Poor's Long-Term Foreign Currency Ratings are expressed in terms of categories (AAA, AA, A, BBB, BB, ...) The highest rating is AAA (not vulnerable to non payment), CC is currently highly vulnerable to non payment, and SD is a non payment default.

• (3) - Institutional Investor's Country Credit Ratings. These ratings lie in the interval 0 (which is the best possible rating for a country) to 100 (which is the worst rating). The 145 countries covered by Insitutional Investor's Ratings are classified two times per year, in september and march.

• (4) - EIU Country Risk Ratings.

November 2001 - Snapshots impressions on Iran

In the background of the September events, one of TAC economist (Ms Morgane Lohézic) had a mission in Iran to assess the economic situation and to highlight the key issues currently facing the country. We thought it could be useful to share her impression.

The most striking feature is the tangible entry of Iran into a phase of transition : it is visible through the speeches of the experts met for business, through more informal conversations with private entrepreneurs or directly in the streets with a larger tolerance in terms of clothes, but also with the emergence of advertisings or the diffusion/projection of American movies in cinemas. We note a real and marked willingness for change from the government, which coincides with Khatami's election and the country's entry into a new development phase. Nevertheless, even though the ambitions of the Khatami government are high, we should not lure ourselves on the fact the different public institutions and large areas of social and economic policy (schools and university in particular) are closely controlled by the "supreme leader" and the clerics, which gives President Khatami a constrained room to maneuver.

The Islamic revolution and the following years of war had transformed Iran into a centralized and planned economy. Because of its forced isolation, the authorities had favored a policy of import substitution. However, most of the non-oil industries are uncompetitive, with heavy protection against imports accompanied by significant problems, ranging from a deficit of image to a lack of quality, and including distribution problems linked to infrastructure deficiencies. The development issues related to this import-substitution bias seem to have been recognized by the authorities, with a very explicit expression of the " necessity " to implement a clear strategy of development outside the traditional oil and gas industry. When keeping in mind that the public sector prevails with nearly 85% of the " formal " economy, it highlights that the privatization of some public companies is indeed one of the key issues of the new five-year plan.

Moreover, there is a core of private companies very active on the Iranian market that are embarking on very ambitious development strategies (including more "sophisticated" areas of industry or services, like information technology or management consulting, very much geared to the domestic market as well as the Middle East and Central Asian regions). Most of the time, these companies are led by managers from the so-called " New Generation ": they made their graduate / post-graduate studies at universities in the United States or in Europe (notably Germany), have decided to come back to Iran despite hazards and uncertainties, and they want their country to benefit from their skills. They appear very confident in the capacities of Iran to develop itself and to open to foreign countries, even though they are aware that the process will be slow and long (between 5 and 10 years), and may be occasionally stopped or even reversed temporarily. All in all, it seems to us that the Iranian economy has entered into a crucial phase of transition, which finds expression in a large and deep reforms movement, which will take time, but will be sustained. This view was unanimously confirmed by our local interlocutors.

Moreover, for most of them, Iran wants and has to " draw lessons from the past ", mainly that the " strict islamisation " of the regime has been a failure. A move towards a more open society, in some way more westernized, appears to be a very strong trend. From an economic or business perspective, it implies a lot of "learning" by Iranians, even on very basic business assumptions and concepts (value added, amortization, marketing, customer satisfaction, etc.). Iran has a very young population, very consumer oriented, asking for new products certainly a major support in future growth, on top of social and political aspirations that the government has to take into account. It is expressed concretely through a way of life modeled on the West, reinforced by access to European, indeed American, TV channels through satellite. In smart or/and fashionable quarters in Teheran, a new type of restaurant emerges, which are real reproductions of US fast-foods where you can listen to western pop music. There is a great fascination for the United States, either for their way of life or their management methods.

Lastly, for most of the people we met in Iran, the recent international events and the US intervention in Afghanistan could only be beneficial for Iran and favor a resumption of dialogue with foreign partners. Iran must step out from its isolation and especially try to restore dialogue with the United States. Observers underline the relative stability of the country compared to the other regional actors, and it is now recognized that Iran will have a say in the future of Afghanistan. This reinforces the country's long-term objective of being a regional powerhouse, notably in the Central Asian republics. Geopolitics and economic requirements coincide and the country has to increase its openness.

Here also, we should not expect a rapid or brutal Iranian " alignment " on American positions (as underlined by the nuanced and somewhat subtle official position since the events of September 11th ), and the idea of a " linear " process of reintegration in the " western " world remains an delusion. However, this does not prevent a gradual " normalization ", American strategic interests and Iranian looking progressively closer to each other.

RiskQuant: Iran (click on the image to enlarge) The Fundamental Balance Charts allow a visualisation of economic and financial performances most relevant for country risk analysis and an algebraic Score gives a synthetic measure of the performance (0 for the best performance and 100 for the worst). The Ratings are the most comprehensive quantitative measures of country risk that are computed through our non-linear methodology. Four different categories of risk are defined, corresponding to different combinations of the five Fundamental Balances : the Development Risk, the Solvency Risk, the Short-Term Financial Risk and the Short-Term Cyclical Risk. For more information on RiskQuant click here.

September 2001 - New light on globalization after the events of September 11th 2001 in the USA

The terrible events having affected the US in the second week of September have shed a new light on the concept of globalization. This was until then a buzzword used mostly to refer to economic and financial developments. Trying to take a long-term view on this phenomenon with the events of September in mind, we would like to share a few thoughts:

• The attacks on the World Trade Center towers and the Pentagon have cruelly exposed that terrorist organizations have switched from localized groups to worldwide networks overwhelming national boundaries.

• The same can be said with organized crime and illegal activities, with strong links between politically motivated organizations and mafias;

• We add that to a historical observation that globalization processes appear to occur regularly in very long cycles, and very frequently end with tragic crises and significant world economic disruptions.

1. The attacks on the World Trade Center towers and the Pentagon have cruelly exposed that terrorist organizations have in turn switched from localized groups to worldwide networks overwhelming national boundaries. Apart from the horror of the images of buildings burning and collapsing with their thousands of lost lives, the most astonishing element of these events is the spread and width of the suspected terrorists' networks, from the US to Europe, the Middle East, East Asia and Africa. No single location can sum it up and it is very doubtful that "terrorist decision centers" can be eradicated by any military might, even if coordinated among a large number of countries. Exactly parallel to the loss of national sovereignty and power on globalized economic and financial forces, these tragic events illustrate that such "global trends" create movements and decisions that escape the traditional realm of national authorities as we know them. And exactly like any substantial recovery of national sovereignty of globalized economic forces would require universal (and therefore unlikely) agreements, any lasting victory on international terrorism would require the same degree of universality.

2. By looking regularly at some specific country-risk situations, we have often highlighted how "weak" political countries were becoming hostages to organized international crime, itself related to international terrorism in many instances. Indeed, it appears that illegal activities have turned into a rather sophisticated and inter-related group of multinational organizations. As one former CIA director was quoted as saying in a Congress testimony, an apparent alliance between Colombian, Russian and Sicilian mafias has made any national policy irrelevant, while clearly posing new threats to political and economic stability worldwide.

3. Do we go too far in relating these extreme events and development of illegal activities with the economic and financial globalization? Notwithstanding the violent demonstrations that have become a regular feature of international meetings (IMF - World Bank, WTO, G8), we would like to put forward the following arguments:

   • It is naïve to portray the terrorist organizations as relying on some backward obscurantist groups of people easy to convince with extreme arguments. If we look at any terrorist group today, we cannot but be amazed by the fact that they attract many western-educated and highly sophisticated persons. The two individuals whose pictures were presented on TV as being some of the highjackers in the US tragedy were bright Saudi citizens very familiar with western culture and ways of life. And we would certainly suggest today to have a second look at the well-publicized book by Benjamin Barber, "Jihad vs McWorld" (1995, Times Book, New York), to better understand that economic globalization and extremist reactions are very much interlinked.
   
   
   • Contrary to what is often portrayed, economic and financial globalization is neither a decade-old trend, nor the direct consequences of a completely new paradigm concerning technology and transfers of information. It can be argued that globalization and national inward-looking movements have followed very long cycles over history. The great discoveries and Southern European countries' expansion during the 15th-17th centuries (equally associated with significant technological changes) have brought a very large degree of trade, economic and monetary inter-relations worldwide; because the major benefits from this international integration were so poorly distributed among the various parties to it, it ended with bloody anti-colonial and independence wars. A second wave of European expansion at the time of the industrial revolution, and the building of the British and French Empires were also associated with deepened economic and financial integration. The colonial companies were as multinational as our top 100 largest corporates today; international bonds, international project finance, large flows of trade and money across borders have had a critical influence on countries. Here again, it ended badly, with both economic dislocations (major bankruptcies and financial defaults, wave of nationalizations, other anti-colonial wars), even though on a longer period of time.
   
   
   • We derive from this (over-simplistic) historical survey two major conclusions: (1) Globalization has always been positive or favorable for the dominant economic and political powers of the time, but very scarcely so for the other countries or regions; (2) Because these unequal benefits are unsustainable in the long-run, the phases of globalization have most often ended tragically, be it through wars and widespread conflicts or through deep economic crises and financial meltdowns.

September 2001 - Image Quizz

What is pictured here ?

1. A photo of planet jupiter?
2. A neural network map of some French companies?
3. Viral particles seen by scanning electron microscopy?

The answer is: "A neural network map of some french companies".

We have created this map using a database of financial accounts on 32000 French companies. We use a specialized neural network, a self-organizing map, to divide the sample into clusters and reduce the number of dimensions of the input data. The image represents the clusters with gray levels: a white zone is an homogeneous zone (or cluster) and a black zone is a "hole" between two or more clusters.