Economic Outlook for 2014

Dear friends, following are some of the important economic themes for this 2014.

As always we welcome any feedback, I have mode detailed information about each of the topic discussed below but I have summarised the content to fulfil the purpose of this blog which is meant to be informative but not the place where to analyse in depth each subject. If anybody is interested in additional information please connect with me directly using the contact form at www.affinitasconsulting.ae or info@affinitasconsulting.ae.

Overview

We recommend a cautious investment approach to 2014. While at the turning of the year many media outlets run big optimistic titles for 2014 we remain instead very prudent and skeptical about the health of the global economy. We see several reasons for weakness especially in the equity sector. Clearly, as always even weaknesses or a downturn uncover opportunities for successful money making but we leave those strategies to the people in the field and we would rather concentrate the following analysis on long term trends likely to affect economic growth instead.

The tapering of the US QE exercise is bound to have ripple effects globally, especially across the emerging market economies.

We reckon the US economy is not as healthy as mainstream media believes and we expect the Feds to evaluate tapering sometimes after Summer when additional signs of weaknesses are going to appear. Now that the elections in Germany are over and done with, and the upcoming banking stress test from the ECB looming we expect the Eurozone to create some waves again. Spain and Italy are bound to catch the spotlight: the first because of weaker than expected banking system and the latter because we expect the government to be challenged in the coming months.

Bottom line: it may be time to cash out on the equity gains accrued over the last few months and wait for bargains during the volatility that is bound to take place due to the tightening moves of the next few months. Some institutional investors or asset allocators may look into specific infrastructure projects which have demonstrated a low correlation with equity markets oscillations.

Investors or asset allocators may also explore and evaluate financial instruments that have as objective the isolation of the interest rate differentials.

A STRONGER DOLLAR

The tapering program announced by the Federal Reserve is going to be one of the key elements behind a likely appreciation of the USD against the other G10 currencies.

I believe we will see an even appreciation of the currency throughout 2014. While portfolio flows in 2013 definitely favoured Europe we believe that strong equity valuation discounts eliminated any chance for further growth hinderances. 

In addition US Banks are decreasing their exposure against foreign borrowers and we see this as a clear sign that the USD is no longer used as a funding currency but rather as a destination for investment.

With specific regard to the USD/EUR rate we simply believe that in spite of the PR coming from the EU there are significant unresolved problems in the Eurozone that are bound to flare again at any time (more below on this topic - EU problems all over again).

We are forecasting the following key rate: 1.20 $/EUR 

USD Investment Destination (Graph)

PRESSURE ON CORPORATE PROFITS

This topic is directly linked to a phenomenon that many economists have been discussing for more than a decade: the decoupling of productivity and wage growth, the so called Jaw of the Snake.

The decoupling between productivity and wage started to appear around the beginning of the 80s, we believe that the spread of the personal computer and the adoption of information technology greatly favoured this trend. 

Fundamentally: since 1990 German labor productivity increased by 25% with no appreciable difference in wage growth; in the US labour productivity has increased to-date 85% versus only 35% of the hourly wage. In a study published in 2012 & 2013 by the International Labour Organisation we learned that the share of labor as part of the gross national income has declined since 1975 by more than 10% across the 16 high-income economies.

This allows for a redistribution of the national income away from labor and in favour of capital owners.

ILO (International Labour Organisation) research goes therefore at the core of the problem: the decline in the labor share of the national income hinders aggregate demand; that is because the consumption propensity from labour income is much higher than the propensity to consume out of capital income.

We therefore believe that pressure on corporate profit will come directly from the spreading income inequality that is accelerating in many of the G10 economies. In fact, lower aggregate demand lowers government tax collection, and further hinders the ability and willingness of companies to invest.

Adjusted Labor Income Shares (Graphs)

Increasing Income Inequality (Graph)

EU PROBLEMS ALL OVER AGAIN

While the marketing machine hails the Banking Accord of 2013 we believe that its positive effects will take very long time to take effect, and during this time a lot can and will happen. Be aware that the resolution fund part of the accord will not reach its target till 2026! 

Throughout 2014 there are going to be several junctures testing the solidity of the union and especially its banking system. We expect the upcoming banking stress test by the ECB to be one of such tests. It is likely that the test is going to uncover the requirement for additional capital especially in Spain, Greece and Italy. The stress test is promised to be more stringent than the previous one, especially since the previous one proved to be inconclusive since after passing it with flying colors the Spanish Bankia, the Cyprus Laiki and the Franco-Belgium Dexia went belly up just months later.

We also believe that the Spanish economy hasn’t sufficiently deleveraged, especially in its real estate sector.

The figure below shows that notwithstanding the collapse of property prices, Spanish mortgage debt has adjusted by only half the magnitude of the US adjustment. 

Any alarm in the banking sector would have repercussion on the valuation of the sovereign debt. The vast amount of Spanish government debt is in fact held internally by domestic banks.

IMF projections give the Spain structural deficit as one of the worst globally over the next five years. It is likely that additional fiscal tightening is going to be required in the upcoming future to meet the required targets.

We remain quite pessimistic in the future of the Euro zone in spite of the victory speeches of some of its leaders. 

Since the local governments are going to be forced to fund their own bank bailouts till the European fund gets up-to-speed we expect a continuing shortage of credit. With a chronic shortage of credit given to the private sector we expect growth to remain weak or non existent for most of the EU countries and deflationary forces will remain at play during the entire year.

Reality will seep through in 2014 and equity returns should start to be driven by corporate earnings instead than Quantitative Easing operations by the central bank. 

It is clear that Eurozone leaders have addressed some of the issues on hand and made significant steps forward, especially steps that have been blessed by the German leadership. Nevertheless these steps remain insufficient to resolve the disparity between the different countries in the zone and time may be running out before additional shocks are going to rock the system.

Reverse globalisation

Global trade hasn’t recovered to the same levels prior of the 2008 crisis and its growth remains below trend since 2011. Further note that additional data leads us to believe that there is an underlying trend of re-shoring currently in place.

The Manufacturing Advisory Services survey show that among 500 UK small and medium size companies interviewed a significant percentage of them was in the process of reshoring or thinking about it.

15% of the manufacturing business in the South East was already reshoring and an additional 25% of the companies was considering reshoring activities over the following 12 months.

Shipping Remains Subdued (Graph)

Similar trends are not exclusive to the UK manufacturing industries but also in the USA where industrial reshoring has been a key theme of 2013. In the USA the trend is predicated on the falling energy prices (“fracking revolution). 

Over the next decade as labor cost rise in China and other Asian exporters we predict this trend to gain pace.

Shipping Indexes (Graph)

Reasons for Re-Shoring (UK)

DEBT SERVICE BURDENS

As the monetary stimulus keeps on being retracted the lid that was put on government bond yields is going to be lifted little by little. It is therefore normal that interest rates sooner or later are expected to be raised.

Our point is that as this happens we expect service burdens for household to rise and therefore depress consumption expenditures.

Debt Servicing Costs

We indicate few countries that are likely to hit particular consumption degradation at the rising of interest rates: Canada, Netherlands and Sweden. These countries experienced a fair amount of household leverage during the last 10 years with no sign of decrease since 2008.

A study from the Canadian Chartered Accountants found that 29% of the respondents would struggle to keep up with payments if interest rate rose by 2% and further 29% would consider challenging more than 3%.

Canada, the USA and Sweden have a high proportion of non mortgage variable debt outstanding that is used for consumption. As monetary policy keeps on tightening over the course of 2014 investors are best to avoid any consumer centric type of equities.

Interest Rate Vulnerability (Graph)

Please contact the Affinitas Consulting team (www.affinitasconsulting.ae) for any additional query or information.

Livestock industry in Georgia - investment opportunities

Preamble

The issues revolving around the ecological impact of food supply are one of the topical problems in the 21^st century world. That is why Affinitas Consulting regularly provides articles about the situation and the opportunities in different directions of agricultural sector in Georgia, one of the countries in the Caucasus that is seeing a revival in agriculture interest. This article is dedicated to the livestock sector and will provide information about:

• The current situation of this business in Georgia;
• The challenges related to the production process;
• Statistical and economic data;
• Specific information about pork, beef and mutton production in Georgia;
•  Existing livestock project implementations and potential opportunities in the Georgian industry.

Current Situation

Livestock was and is one of the major sectors of the agricultural sector in Georgia. Archaeological excavations together with Georgian monuments prove that even in the ancient times this sector was highly developed in the country.

However, nowadays this sector while offering a lot of potential to foreign investors it is suffering from some internal issues.

Problems date back to Soviet Union times when farmers were only asked to grow the animals and the government guaranteed price and guaranteed all other steps of the supply chain. Nowadays free market conditions force small farmers and entrepreneurs to face competition with foreign investors at a disadvantage due to a chronic lack of credit and therefore investments as well as knowledge.

Therefore this sector is currently proceeding by virtue of inertia. In order to accelerate development process almost every government of Georgia initiates some initiatives, however the problems stay the same and is mostly linked with the lack of financial resources.

The table provided by Georgian Statistics Department is great proof of such opinion. According to the department only 8.8% was the share of agriculture in the country’s total GDP in 2011. Such percentage is especially alarming after taking under consideration the fact that 50% of citizens are employed in the agricultural sector.

 The Share of Agriculture in Total Georgian GDP:

But the fact that livestock takes about 50% of the total agriculture share is quite interesting:

Livestock’s Major Sectors

Sheep Breeding

Sheep breeding is one of the most interesting and ancient sectors in Georgian livestock. The legend of Argonauts, according to which sailors (Argonauts) visited Kolkheti (Georgian territory) to get the so called Golden Fleece – Sheep leather is quite a good evidence of that.

There are two types of Georgian sheep: Tushuri and Imeruli.

So called Tushuri sheep is mostly spread in Eastern part of the country. Such breed is very popular, mostly because of its main characteristic: endurance. Tushuri can walk about 600-700 kilometers per season, it has strong leg and can easily be adapted to environmental conditions.

Tushuri doesn’t need high quality food, it can be fed in semi-desert lands and weights about 60-80 kilograms.

Imeruli sheep is mostly spread in Western part of the country, has more rude wool and its uniqueness is in its reproduction functions.

It can be bred any time of the year, it breeds about 2-3 sheep per gestation period and its pregnancy period is shorter, about 137-143 days.

Such variety of sheep weights about 35-45 kilograms and its meat actually doesn’t consists of fat and so is dietary kind of food.

It should be emphasized that during Soviet Union about 2,000,000 sheep was recorded in the country, however nowadays the number came down to 800,000 units.

Such decrease is the result of different factors, however it’s mostly linked with finances. Since the taxes on pastures increased, the farmer that had limited financial abilities had to sell even such sheep that in future should have lambs.

Markets for Georgian sheep realization

It’s noteworthy that mutton consumption in Georgian is quite low, about 70 tonnes per year and is mostly depended on the Azerbaijanis living in the country.

However the interest towards Georgian sheep, namely in Tushuri is quite high in foreign countries, as this breed is very similar to sheep from Middle East Awassi, which is very popular and quite expensive in Arabian countries.

If the price for Australian Merinos sheep in Arabian countries is about $8 USD and for Syrian Awassi is $15, price for Georgian sheep occupies middle position between them.

Nowdays, Tushuri sheep is exported in Libya, Syria, Jordan, Iran, Saudi Arabia, Egypt, Azerbaijan, Qatar, Kuwait, United Arab Emirates, Oman and in Israel.

About 266,244 live sheep were exported in 2009 year from Georgia, in 2012- 178,000, in 2011 – 150,00 and in 2012 about 120,000.

Domestic sheep is also interesting from wool point of view. If one sheep can give about 2-2.5 kilograms of wool and a lamb about 1-1.5, it comes out that Georgia has capacity to produce about 1,700,000 kilograms of wool per year. While domestic price per kilo of the product is about $6 USD.

Sheep is also attractive in terms of milk production, especially for cheese production. It gives less milk than a cow, about 1-2 liters, however its milk is full of fat and is beneficial for health.

Important to note is the fact that the export can be much more, as the interest towards Georgian sheep is large and considering the current World food trends it will only increase.

Pork and Beef Production

Pork and beef production is more relevant in Georgia, as the demand for them is higher on domestic market also.

Nowadays the retail price for beef in Georgia varies between 9-11 USD, while for pork between 8-11 USD.

Cows average weight is between 350-459 kilograms and price for a cow is 500-718 USD. Pigs weight is about 80-180 kilograms with a price of 270-500 USD.

Despite the high demand on local market, farmers and small entrepreneurs are not able to satisfy the market and this shortage is filled with imported goods.

As for example, about 7,700 tones of frozen beef and 7,500 tone of pork was imported in Georgia in 2009 year, with the total price of 12 million and 16,6 million USD respectively.

According to the experts, the most of this shortage space can be supplied by locally produced meat, that nowadays can not be reached because of existing challenges.

However the Department of the Georgian Ministry of Economy and Sustainable Development released quite optimistic data:

In the first quarter of 2012 the share of agricultural products increased comparing with 2011 year.

Structure of exports according to sectors in the first quarter of 2011-2012 years:

For example, the export of cattle was 9,8 mill USD, that is 112% raise comparing the previous year. And it’s noteworthy that 99.6% of this goes to Azerbaijan and 0.4% to Iraq.

According to this department the share of agricultural products is reduced in the total import in the first quarter of 2012year. From 19% it came down to 16%.

Structure of imports according to sectors in the first quater of 2011-2012 years:

However, the import of beef was increased by 60.3% and was about 6.1 mill USD. And 92% from the total import was from India and the rest from Germany, Turkey and Brazil.

Pork import increased by 80% and consisted of 7.2 mill USD, from which 60% was from Brazil and 40% from Canada, Netherlands, United States and other countries.

Despite of meat, cow gives also milk, about 12-13 liters during Summer and 8 liters during Winter.

Along with the seasons the amount of milk given from cow depends on the quality and amount of food it gets. Considering the financial abilities of domestic farmers, it can be assumed that in case of better quality and more amount of food Georgian cow can be milked better.

The process of milk realization is better organized by domestic dairy producing companies. The company representatives regularly visit the village inhabitants and buy milk from them. Or the peasants go to the special places and sell the product.

The price per liter of milk in case of first option varies between 40-50 cents, while in the second case it’s higher.

Conclusion

Existing local demand is able to support the development of a stronger livestock industry in Georgia provided that private investment likely from foreign countries will be focused in the industry.

Considering the above data, it can be easily seen that if livestock business will be developed in Georgia, the existing and growing demand in the Georgian market can easily be satisfied by locally produced goods.

The reasons that caused the delay of the sector’s development are also clear. Similarly to the agriculture sector in general, also in livestock mostly little farmers and peasants contribute to the industry and all of them are unable to expand the business because chronic lack of financial resources (credit) that prevents them to modernize their technology and create economies of scale.

Direct foreign investments can easily accelerate the development process of this sector, that turns out to be attractive and full of opportunities in terms of both directions like export and of supplying domestic market.

We at Affinitas remain available to help any investor interested in starting up agricultural business in Georgia. For further information please visit our web site at: www.affinitasconsulting.ae. Please direct any query to info@affinitasconsulting.ae or join our Facebook page to keep updated on the latest news: www.facebook.com/Affinitas 

Article by: Kate Lekishvili & edited by Luca Gorlero. All rights are reserved. Total reproduction or partial reproduction of the information above is forbidden unless authorized in writing by Affinitas Consulting.