Research Dept. News
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Monthly Report, num 358 - June 2012
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International review
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United States
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The United States: more consumption than income
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The United States maintains its tone of recovery and grows by 2.1%.
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The expansion is consolidating and the downward risks are abating. The Falling oil prices, possible expansionary effects due to the electoral year and the strength of consumption are offsetting the negative consequences that might result from the lack of a credible route map for fiscal consolidation and a potential deterioration in the euro area debt crisis.
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Growth is supported by private consumption and stocks but capital goods investment falls.
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Gross domestic product (GDP) of the first quarter grew by an expected 0.5% quarter-on-quarter and 2.1% year-on-year. Consequently, a large part of the upswing from the end of last year has remained in place and everything points to an advance slightly over 2.0% for the whole of 2012, more than predicted two months ago. However, the composition of GDP did cause some surprise and underlined the modest nature of the recovery. Growth was mostly based on a private consumption that increased by 0.7% and exceeded even optimists' expectations. The second contribution in terms of importance for growth came from the accumulation of inventories, which was also higher than expected. The other side of the coin was provided by capital goods investment, which unexpectedly fell. Although this component should pick up in the second quarter, the end of the upward cycle for inventories and the slowdown in private consumption point to a relatively flat growth trend throughout 2012.
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Private consumption exceeds income and savings return to minimum levels.
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Private consumption should lose steam in the second quarter because debt and wage rises, which are its main sources, are limited. The boost for the first quarter came from a fall in the savings rate, which fell to 3.9% of disposable income, the lowest for the last four years. Household debt has fallen by 17.3 percentage points in terms of disposable income since September 2007 but, nonetheless, the 112.7% of disposable income of December 2011 seems too high, so the savings rate should rise again above 4.0% of disposable income, with the consequent effect of slowing down consumption.
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The latest figures for retail trade suggest this is already happening. Excluding the fluctuating figures for cars and petrol, in the first three months of 2012 the average month-on-month growth in retail sales was 0.8%, while in April this hardly reached 0.1%. The slowdown throughout 2012 should be more gradual, however, as part of April's deceleration was due to strong consumption in the first quarter, boosted by an abnormally mild winter. The recovery in the consumer confidence index of April's Conference Board followed a similar pattern, counting two consecutive months of stagnation at a level that is clearly below the historical average.
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The recovery in the labour market progresses but wage rises will take some time to arrive.
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If the debt option is complicated for consumers, it's the same situation with income. Household disposable income in real terms is practically at a standstill, with a minimal increase of 0.1% year-on-year in March. Households get 64.2% of their income from employment but the trend in the labour market does not indicate much liveliness in wages, in other words household income. In a typical expansion, an increase in employment and the hours worked precedes wage rises but the former is happening slowly and the latter will take its time to arrive. 688,000 net jobs were created in the first quarter of the year, a monthly average of 229,000. The 115,000 jobs created in April supposed a return to normality that, as with retail sales, is excessively abrupt in compensation for the strength of the previous months. The cruising speed of job creation should be around halfway, about 175,000 jobs per month, so that a little more than two years would be required to reach the levels of December 2007. The weekly hours worked remained close to the historical average but the fall in under-employment, which includes workers working part-time involuntarily, was interrupted momentarily in April.
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Investment must recover in the second quarter.
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The most positive indicator for the labour market is still the unemployment rate, down one tenth of a percentage point to 8.1%, nine tenths of a percentage point below the level of the same period a year ago. However, two thirds of this improvement can be attributed to a drop in the activity rate and only one third to job creation. Most of the forecasts see the unemployment rate remaining unchanged until well into 2013.
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Whereas consumption is likely to slow down, the business activity indices of the Institute for Supply Management (ISM) point to capital goods investment rectifying its decline in the first quarter. April's manufacturing ISM index rose to 54.8 points, consistent with robust economic growth. This recovery is also suggested by the services ISM as, although it fell, its level of 53.5 points is suggestive of modest growth but not declines.
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The CPI stands at 2.3% but lower oil prices will push it down.
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Similarly, construction activity over the last few months is looking stronger than expected. The 4.5% quarter-on-quarter growth should continue, given the 717,000 new homes started in April, in annual terms, supposing a year-on-year increase of 29.9%. However, the exceptionally low starting levels mean that its contribution to growth is low and underlines the fact that the sector has yet to see the light at the end of the tunnel. Oversupply will continue until 2013, although prices might have bottomed out. The Case-Shiller index for second-hand housing in February for the twenty main cities put an end to its series of falls with a slight rise and business sentiment has improved to some extent. However, the sector's true stimulus comes from the Administration being able to achieve the restructuring of the debt of the 12 million homes with an outstanding mortgage worth more than the value of their property.
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Stability is the order of the day for prices. The consumer price index (CPI) rose by 2.3% year-on-year in April (2.9% in March) due to the base effects of oil prices. However, the core CPI, which excludes energy and food prices, seems reluctant to confirm its expected slowdown and repeated the 2.3% year- on-year rise of the previous month, supported by an upswing in the price of durables. The balance is being broken and pushed down by oil prices as, if their downward trend continues, the CPI should remain close to 2.0% by the end of 2012. In any case, prices leave room for monetary policy to continue supporting growth.
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The trade balance will benefit from cheaper oil in the second quarter.
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With regard to the foreign sector, March's trade deficit increased to 51.8 billion dollars, 6.4 billion more than in February, which had been abnormally low due to the Chinese New Year celebrations. Most of the increase is centred on the deterioration in its trade balance with the Asian giant. However, March offered two potentially positive notes. Firstly, exports picked up in spite of weak global demand and the relative strength of the dollar. Secondly, the trade imbalance in nominal terms should adjust over the coming months as the effects of falling crude prices, which accounts for 55.1% of the trade deficit, were not included in March's figures.
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Japan
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Japan: an upswing without a continuing solution
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Japan grows by 2.6% in the first quarter thanks to private consumption.
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The upswing exceeded expectations with a first quarter GDP that grew by 1.0% quarter-on-quarter and 2.6% year-on-year. This momentarily places Japan at the head of advanced economies in terms of growth. However, the forecast for the whole of 2012 hardly reaches 2.5%, as the composition of the national accounts raises doubts regarding the sustainability of the upswing.
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Unusually, the growth of the first quarter was based on private consumption, which grew faster than the rest of the components, on the accumulation of stock and public investment which, in the Japanese economy, is particularly fluctuating. However, capital goods investment fell by 3.9% quarter-on-quarter and showed that, the recovery from the tragedy of March 2011 still has a lot of loose ends, to which we should also add Thailand's floods in summer 2011.
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But the fall in investment and the need for fiscal stimuli raise questions regarding whether this upswing will continue.
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Energy deficiencies due to the nuclear stoppage and bottlenecks in production are a spanner in the works for the recovery. This can be seen in industrial production, which in Japan has a greater influence on GDP than in other advanced economies. The industrial production index has regained 82.1% of what was lost in the tsunami and is 2.9% below the level of February 2011, prior to the catastrophe. However, the pace of the recovery has diminished, with March's index being lower than January's level, in line with the deterioration in the investment in national accounts. Similarly, machinery orders, a leading indicator of capital goods investment, fell in March, especially those destined for export.
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The latest demand indicators confirm the strength of consumption. March's retail sales rose by 10.3% year-on-year and vehicle registrations in April continued to recover. However, the need for fiscal stimuli for consumption by the public sector, which is the most in debt of the advanced economies, is leading to doubts regarding whether the upswing will continue. Following these expectations, the consumer confidence index fell in April to 40.0 points, somewhat below the level of February 2011.
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Demand indicators confirm the boost provided by consumption but confidence retreats.
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There are also doubts regarding the momentary halt in the deflationary dynamic. March's CPI rose by 0.4% year-on-year but without the effects of the higher oil prices in the first quarter of the year while core CPI, the general index without energy or food, stalled, accumulating a drop of 0.4% year-on-year. Fuelling this scepticism, Tokyo's prices fell in April. For its part, the trade balance has seen an uninterrupted deficit since October 2011 to March 2012, an accurate reflection of the difficulties in supply and the costs suffered by export firms, particularly those from the consumer electronics sector.
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China
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China: the slowdown has yet to endanger the soft landing
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Slowdown in most activity indicators in April for China.
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The weakness in most business indicators and the deterioration in the foreign sector during April have surprised most analysts following the Asian giant as they expected a somewhat more moderate slowdown. And although our main scenario still contains a soft landing for the country, these events, together with the possible worsening of the euro area crisis, call for greater forcefulness in monetary and fiscal policy to support growth.
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Industrial production exemplifies this slowdown, contrary to what had been suggested by the purchasing managers' index (PMI), which rose for the fifth consecutive month to 53.3 points. Industrial production grew by 9.3% year-on-year in April, below the 11.9% of March and of the consensus forecasts, which had placed it at 12.2%. Similarly, retail sales grew by 14.1% year-on-year in current terms, one point below March's figure and consensus forecasts. For its part, investment in fixed capital for the first four months grew by 20.2% year- on-year, 0.7 points below the cumulative figure up to March.
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With regard to exports, these grew by a meagre 4.9% year-on-year compared with March's figure of 8.9%, due to the fragility of advanced economies. The disappointment was even greater for imports, which hardly increased in year-on-year terms (0.3%) and saw a new record drop in monthly terms, placing the trade surplus at 18.4 billion dollars. Weak imports are a consequence of the moderation in foreign demand, as shown by the sharp drop in exports of processing and assembly, although this is also indicative of easing private consumption and investment.
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Weak imports indicate a weakening both in the foreign sector and consumption and investment.
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Within this environment of moderate activity and lower risk of overheating (inflation fell slightly to 3.4% compared with the high 6.5% of last July), the executive will have to speed up its policies of monetary relaxation and proactive fiscal policies as announced at the last National Congress in March. In particular, we predict further falls in the reserve ratio, which will be added to the recent cut of 50 basis points in mid-May, and more effort devoted to increasing access to credit for small and medium-sized firms. Fiscally, the Chinese government, in addition to continuing with its plan to reinforce welfare benefits, the construction of subsidized housing and improving infrastructures, also aims to stimulate private consumption with lower taxes and subsidies.
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Monetary relaxation and proactive fiscal policy are required.
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In short, given the moderation in most supply and demand indicators, and the weakness in the foreign sector, it is clear that it is still far too soon to talk of changes in the country's growth engines towards domestic consumption and private investment. And as we mentioned last month, we will have to wait and see how the main indicators evolve over the coming months and how the mix of monetary and fiscal policies affect China's economic activity.
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Brazil
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Brazil: fruitless stimuli
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Brazil's economy is slowing up more than expected.
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Of the events occurring recently on the world economic scene, three have significantly affected the current fate of Brazil's economy. On the one hand, the confirmation of China's economic slowdown in the first quarter; on the other, the progress made in correcting commodities markets and, lastly, more intense tensions in the euro area's debt markets are causing a marked upswing in global aversion to risk.
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We hardly need mention that China's slowdown and the lukewarm commodities markets are having a significant effect on Brazil's economic activity as they reduce its main foreign market. This would explain, in part, the disappointing growth rate of the Brazilian economy this year so far, as can be seen by leading macroeconomic indicators. Just a few days before the official data from the national accounts confirm this, the latest figure given for the monthly activity index suggests that gross domestic product (GDP) will have fallen by 0.35% in March compared with February, limiting year-on-year growth for the first quarter to little more than 1%, in line with the figure posted in the last quarter of 2011.
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These figures, together with the persistent decline in industrial production and the perceptible weakening of employment reveal a clear moderation in Brazil's rate of economic growth. A greater moderation than expected, particularly taking into account the marked expansionary tone of economic policies since last autumn, leading Brazil's own Central Bank to revise downwards its growth forecasts for 2012. Given these circumstances, the Brazilian economic authorities have reacted quickly and have already announced a new package of fiscal stimuli to support demand. This package includes both tax cuts (on financial transactions and vehicle purchases) as well as credit facilities for corporate investment in capital goods and for purchasing automobiles. For its part, the central bank has also hinted that the tax cuts might continue for longer than expected, so that we do not rule out the SELIC rate going below 8% this year.
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The stimulus tap is still running.
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With regard to exposure to the European turbulences, the real is still one of the most vulnerable currencies to upswings in global risk aversion and, since early May, has already depreciated more than 8% against the dollar and more than 4% against the euro. At the beginning, the authorities did not disapprove of this trend as they considered it to be beneficial for a manufacturing export sector that had been hard hit by the strong real of late. However, Brazil's Central Bank has just intervened, and forcefully, in the exchange markets in order to stop the local currency from depreciating to below the threshold of 2 reais/dollar, a level that seems to be proposed as a new minimal support.
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Whether the current scenario of a slowdown and depreciation continues will largely depend on how long it takes to resolve the outbreak of tension regarding the euro area's debt crisis and whether this ends up reducing the confidence of economic agents in Brazil. In any case, we should expect Brazil's authorities to continue making use of stimuli but these might not bear fruit, at least in terms of growth, in 2012 but rather in 2013.
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Mexico
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Mexico: a tail wind... but on the alert
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The real, at the mercy of global risk aversion.
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In the first quarter of 2012, Mexico's GDP provided a pleasant surprise and grew by 1.3% compared with the previous quarter and 4.7% with regard to the same quarter in 2011, posting advances in all branches of activity. The gradual consolidation in consumer confidence, solid growth in credit and the good tone of employment, remittances and wage rises continue to augur good prospects for domestic expenditure over the coming months. However, the latest macroeconomic indicators indicate some moderation.
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The Mexican economy advances at a firm pace with 4.6% growth in the first quarter of 2012.
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On the one hand, retail sales grew less than expected in March and less than in February (4.5% in year-on-year terms versus 7.6% the previous month); on the other hand, industrial production fell in February by 1.7% compared with January, in spite of still increasing in year-on-year terms. Similarly, in the foreign area, there is still a risk of worse figures than expected resulting, on the one hand, from the possibility that economic growth in the United States will be less vigorous than expected and, on the other, of continuing excessive financial tension in the euro area.
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Given this scenario, the latest communiquè from the Monetary Policy Committee has yet to draw the line under greater lassitude in its policy if circumstances so require. Nonetheless, given a relatively stable domestic expenditure, inflation still above the central goal of the objective range and renewed tension in the world's financial markets, we still don't expect any changes in Banxico's monetary policy in 2012.
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Where we do expect changes is in the government. The latest polls continue to point to the PRI winning the elections and give increasingly fewer possibilities to the PAN candidate, the party currently in power. In any case, it is very unlikely that the winner will be able to govern alone, so that pushing forward the pending reforms will require the opposition's support. In this area of reforms, it should be noted that, in April, the government introduced some measures to simplify the tax system, increase revenue and reduce fraud. A step in the right direction but the new legislature will have to give more.
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Commodities
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Widespread drops among commodities
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We still don't expect any changes in the monetary policy.
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Oil intensified its correction and, between 20 April and 21 March fell by 10.7%, reaching 109.10 dollars per barrel (Brent quality, for one-month deliveries). Crude was therefore 1.1% above its level at the start of 2012 but 2.1% below its level of a year ago, which will pull down April and May's CPI in most economies.
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Oil drops by 10.7% in one month and is still below its level last year.
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Oil prices confirm that they are following the downward trend due to Saudi Arabia's increased production and the effects on the demand for crude of the euro area's weakness. Its journey along this downward path will keep to 2012, as the long-term trend in supply and demand, particularly in the emerging economies, would support moderate increases in oil prices as from 2013.
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Drops in the rest of commodities are concentrated in metals, affected by China's slowdown.
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The rest of commodities joined crude's downward slide, particularly metals, affected by China's slowdown. The CRB index fell by 1.6% between 20 April and 21 May and, in the year-to-date, loses everything it had gained up to the start of March. Among metals, of note is the 7.3% fall in iron and 6.6% fall in copper, which has accumulated a loss of 9.7% since its peak at the beginning of March. Aluminium and nickel second the drop. Even sharper is the correction among precious metals, with large falls in silver, platinum and palladium. Among foods, the trend is uneven, with rises in wheat and falls in sugar. For its part, gold was down a relatively modest 4.1%, standing at 1,590 dollars per ounce.
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The rise of the international insurance market
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In the last few decades, the world's insurance industry, which already handles around 23 trillion dollars in assets, has undergone an unprecedented expansion. In 2010 it totalled no less than 4.3 trillion in premiums, almost 80% more than in 2000, thanks primarily to the dynamism of the life segment and the growing contribution of emerging markets, whose total premiums increased by more than 150% (in real terms) throughout this period. In 2010 alone, it grew by 11%, with Asia and Latin America contributing the most, up by 19% and 8% respectively, compared with 1.4% in industrialized countries.
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Nevertheless, insurance penetration, measured as the ratio of total premiums over gross domestic product (GDP), is still very modest in these emerging markets: 3% compared with 8.7% in advanced countries in 2010. This is also the case of insurance density, measured in premiums per capita: 111 dollars versus 3,527 dollars per year in advanced countries in 2010. These figures suggest that there is a huge potential in emerging economies. But which factors might help to realize this potential?
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Essentially, the factors fostering insurance market development vary by segment: life versus non-life. However, in general, their development is closely linked to the fundamentals of the real economy and particularly to the average income level. As illustrated in the graph below, the relationship between income and insurance density is markedly positive. The greater the income level, the higher the insurance density. Consequently, it comes as no surprise that, given their fast rate of expansion and their increasing contribution to global growth, emerging economies are also the ones that have most boosted growth in insurance business over the last few years. While their contribution to global GDP has increased from 21% in 2001 to 34% in 2010, their overall share of life premiums has gone from 5% to 14% and non-life from 7% to 16%.
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In the non-life segment, the main driving force is definitely economic growth. It has been estimated that a 1% rise in GDP per capita would be associated with a 1.3% rise in insurance density (premiums per capita). Apart from that, institutional quality has also been found to exert a significant influence, particularly contract enforcement. The number of automobiles, population density and the volume of foreign trade also seem to foster thethe development of this segment.(1) Nonetheless, the evidence available for this area is still limited as, to date, the vast majority of the empirical studies have focused on the life segment.
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(1) See, for example, Feyen, Lester and Rocha (2011) «What drives the development of the insurance sector?», World Bank Policy Research Working Paper 5572.
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With regard to the life segment, its progress is also positively and significantly linked to economic prosperity but as from a certain threshold. Its rise requires a minimum level of development that ensures the emergence of a middle class and sufficiently liquid capital markets. It therefore tends to develop later than the non-life branch, when a suitable number of households achieve a reasonable level of income, which is estimated at a GDP per capita of between 5,000 and 8,000 dollars (in dollars from 2007)(2) and regulations and the local capital market have sufficiently matured. From this point on, when it becomes profitable, it usually grows faster than the non-life segment, with an income-elasticity (where income is measured as GDP per capita) estimated at around 2. In other words, a 1% rise in GDP per capita would be associated with growth in premiums per capita of around 2%.
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In addition to economic growth and credit market development, progress in the life branch also depends crucially on other elements, including the existence of a public pension system, demographic factors and elements of a cultural or religious nature. A wide-ranging social security system (measured in terms of contributions) tends to lower the demand for life assurance, both because it reduces the need and also because it reduces the level of disposable income after tax and contributions. A longer life expectancy also has a negative effect on the demand for life assurance, which suggests there is less demand for life insurance when there is less likelihood of a premature death. A larger proportion of Muslims in the population also reduces the demand for life insurance. This relationship can be explained by the fact that, in some Islamic countries, life insurance is seen as not compliant with Sharia law. Life insurance is also less in demand with a higher rate of inflation, since a highly inflationary environment reduces the value of life policies. On the other hand, it has been observed that a larger population pushes up demand for life insurance, reflecting the positive effect of a larger client base, which facilitates risk pooling and economies of scale.
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In short, the findings suggest there is some margin to speed up the development of the insurance sector from the institutional sphere: by promoting a solid economic environment and lower inflation; establishing a robust legal framework; encouraging the development of credit and capital markets; and by liberalizing the insurance market to enhance competition and productivity. On the other hand, insurance firms can also boost their penetration in emerging markets by diversifying their distribution channels, reaching a broader section of the population (there is a lot of room for exploitation in the bankassurance business in particular); innovating in products (as already done with new insurance policies against climate risks for agriculture or micro-insurance) or by adapting them to the cultural and religious background of each country (such as Takaful products, adapted to be compliant with Islamic Sharia law).
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On balance, development in the insurance sector can bring about substantial benefits: it reduces the uncertainty and impact of large losses, allows risk to be managed more efficiently, supports commercial activity and thereby fosters investment, innovation and competition. In short, it constitutes a fundamental pillar in a country's financial and economic development, so that it is really worth laying the foundations to promote its growth and sustainability.
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(2) See Lester (2009), «Introduction to the Insurance industry», Primer Series on Insurance Issue 1, The World Bank.
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This box was prepared by Marta Noguer
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International Unit, Research Department, "la Caixa"
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