Research Dept. News
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Monthly Report, num 358 - June 2012
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European union
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Euro area
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The Euro area: remaining in a zone of turmoil
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The new European mantra is austerity with growth.
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Two political events, due to the elections in France and Greece, will have important economic repercussions over the coming months. Firstly, the recently invested president of France, François Hollande, met with the German chancellor, Angela Merkel, to agree the new European mantra: austerity with growth. The aim is to curb cuts in order to avoid the risk of economic activity contracting, which would jeopardise the financial viability of member states.
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For the moment, no specific measure has been announced that helps to formalize the new European consensus and move towards solving the crisis that is gripping Europe. However, some members of the European Commission, such as the European Commissioner for Economic and Monetary Affairs and the Euro, Olli Rehn, has shown themselves to be in favour of encouraging public investment in key areas. In this respect, the structural and cohesion funds, together with reinforcement from the European Investment Bank, might serve to implement this policy without violating the fiscal compact.
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Secondly, Greece's elections resulted in a split parliament. Due to their differences on the financial bail-out plan, the Greek parties were incapable of coming to an agreement to form a government and new elections are to be held on 17 June. Given that the polls favour the parties that reject the current bail-out conditions, some European economic specialists have reflected on the possibility of Greece leaving the euro. To date, the official position of the European Union is that the Greek republic will remain in the euro area, although the final decision of whether to leave the single currency will be down to the Greeks themselves.
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Growth in Germany stops the euro area from entering into recession.
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In short, the announcement of the date of the elections has not extinguished the hotspots in the financial markets. Rumours and denials, normal in all confused situations, are also combined with an absence of effective leadership and continue to cause turmoil that is difficult for the European economy to digest.
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Given the political and economic uncertainty, deposits are leaving Greek banks as a precautionary measure, which ultimately increases the fragility of the whole system. At the same time, the doubts of international investors as to whether Greece is the only country that might leave the euro increased the pressure on the rest of the Member states. Moreover, the nationalization of Spain's fourth largest bank created uncertainty regarding the state of the country's financial system and the government's capacity to restructure its bank sector, if necessary. Both circumstances have caused the latest financial turbulences in Europe.
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The evident risk is that, should this uncertainty continue over several months, it might harm economic activity. And the latest figures on gross domestic product (GDP) for the first quarter are not particularly encouraging either. Economic activity remained at a standstill in the first quarter, as GDP had zero quarter-on-quarter growth. The economy therefore avoided going into recession after the 0.3% decrease recorded in the fourth quarter last year. Strong GDP growth in Germany (0.5%) was hindered by zero growth in France (0.0%) and falls in Spain (-0.3%) and Italy (-0.8%). In other words, Germany's strong growth avoided the recession in the euro area. However, a clear slowdown in economic activity can now be seen, as reflected in the year-on-year rate, down 0.7% to 0.0%.
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The weakness of the labour market and political uncertainty do not augur a recovery in consumption.
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From the point of view of demand, March's retail and consumer goods figures reported month-on-month growth of 0.3%. With this rise, the year-on-year rate improved from -2.1% to -0.2%. However, retail sales are the perfect reflection of Europe's economic situation with vast discrepancies between the weakness of the peripheral countries and the strength of the central states. Germany and France posted month-on-month growth of 0.8% and 0.9% respectively, while Spain posted a fall of -0.5% and Portugal -2.2%.
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However, European consumer confidence, standing at -19.9 points in April, remains below its historical average and even worsened compared with the figure for March, namely -19.1 points. There are two factors that are holding back the recovery in household consumption, hindered by the lack of confidence. The first is the weakness of the labour market, posting a further increase in the unemployment rate in the month of March to 10.9% and producing the highest unemployment rate for the last fifteen years.
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Exports continue to contribute to the growth of the euro area.
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The second factor is political uncertainty regarding the outcome of the future Greek elections. Both factors are increasing uncertainty and this is very likely to make households reluctant to consume over the coming months.
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Industrial production in the euro area continues to contract.
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Fiscal austerity plans are stopping public spending from boosting the economic recovery. However, the component of net exports continues to contribute positively to GDP growth. The trade balance figures for March reported a surplus of 4.3 billion euros compared with the previous figure 4 billion. Imports dropped by 1.1% month-on-month while exports shrank by 0.9% month-on-month. By country, of note is the large German trade surplus of 10.5 billion euros.
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From the point of view of supply, the euro area's industrial production fell by 0.3% month-on-month in March, increasing the fall in the annual indicator from -1.5% to -2.2%. In spite of Germany's 1.3% month-on-month rise in industrial production, this was not able to offset the falls in France, -1.8%, and Spain, -0.9%. By subsector, the largest drop was in the energy sector, with a month-on-month decline of 8.5%. Unfortunately, the business confidence figure, which fell again in April, does not indicate any upswing in industrial activity over the coming months.
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Inflation is under control.
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One of the consequences of the lack of activity in Europe can be seen in the lower rise in prices. April's consumer price index increased by 2.6% year-on-year, one tenth of a percentage point lower than the figure for the previous month, as suggested by the preliminary data. For its part, core inflation, excluding the most volatile components of food and energy, remains at 1.6%. The most inflationary items in April were clothing and footwear, energy for transportation and electricity. Inflation is approaching the forecast by the European Central Bank (ECB), which estimates that it will end up close to 2.3% by the end of the year. However, the fall in oil prices, started in April and speeding up in May, might be partially offset by the euro's depreciation due to the latest turmoil. Nonetheless, inflation will continue to fall over the next few months.
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In short, the lack of resolution for the Greek situation and its impact on the financial markets continues to grip economic agents and is leading to consumption and investment decisions being put off. Last year, vacillation in the euro area's political management proved to be the economy's worst enemy. In terms of the future economic trend, it is important to avoid a repeat of the hesitation in taking decisions and to commit to definitive solutions for a financial crisis that has already gone on for five years, since its beginnings in the summer of 2007.
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Germany
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GDP provides a pleasant surprise in the first quarter in Germany
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The GDP figures for the first quarter confirm that the decline in activity in the fourth quarter of 2011 was a temporary bad patch and that the German engine has started to move ahead again. In fact, the 0.5% quarter-on-quarter growth exceeded expectations and placed the year-on-year rate of change at 1.2%, nevertheless a sign of a slowing trend. In May many opinion indicators, such as the ZEW and Ifo, recorded an abrupt fall, affected by the intensification of the uncertain climate in the euro area. We have therefore raised our average growth forecast for the year only slightly to 0.6% in 2012 as a whole.
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In May, Germany's leading indicators post an abrupt fall, affected by Europe's uncertainty.
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The rise in GDP in the first quarter was particularly helped by the foreign sector. In fact, the 1.7% increase quarter-on-quarter in exports, due especially to demand from the emerging countries, and stagnated imports led to a contribution of 0.9 points to the quarter-on-quarter expansion. Also private consumption, which rose by 0.4% in the quarter, provided a positive contribution. However, investment, both of capital goods and construction, which suffered from the bad weather in February, saw a drop.
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The favourable performance by the labour market and the rise in disposable income continue to support private consumption.
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Regarding the second quarter, the outlook for consumption is quite favourable, supported by the expectation of a rise in disposable income and in the level of employment. In fact, the labour market continues to perform well. In the first quarter employment was 1.5% above the level for a year earlier, while the number of unemployed people fell. Both the greater flexibility achieved after the labour reforms and the moderate behaviour of wages have boosted the labour market.
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In fact, there are even signs of unfilled job vacancies in some branches. For this reason, in mid-May the German government passed another law to help qualified immigrants from other countries in the European Union enter the country by creating the so-called «blue card».
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From the point of view of supply, industrial production rose in March and posted a 2.2% increase in orders, improving the outlook. The euro's recent depreciation might also act as a boost for the sector. With regard to construction, February's slump due to the bad weather picked up again in March. Orders increased by 10.0% in February compared with twelve months before and in real terms, a sign of a favourable trend in the future.
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Although it's true that the increase in German imports helps to reduce current account deficits with its EU partners and boosts growth, more voices have started to be heard pointing to its insufficiency and suggesting that more stimuli might be needed for German growth. Higher wage increases have therefore been proposed. Moreover, the relative defeat of the Christian Democrat party in the regional elections of North Rhine-Westphalia could be put down to the government's austerity policy. In spite of these signs, no clear change in direction for economic policy can be seen.
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Germany's 2013 budget reduces the bureaucratic burden for firms but does not show any clear change in direction to stimulate growth.
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Some of the new elements in the proposed budget for 2013 approved by the government in May are the reduction in the obligation to conserve tax and accounting documentation from ten to eight years, extendable to seven in the future. It is calculated that firms will save 1.7 billion euros in the first phase of this new measure. On the other hand, the tax regime for electric cars has also been improved, with deductions on the cost of batteries, to boost their development.
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France
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After stagnation, a change of scene for French economic policy?
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France's economic climate cools down in May due to the rise in economic uncertainty.
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France's statistics institute confirmed the French economy's stagnation in the first quarter and the year-on-year rate of change stood at 0.3%. In April, the economic climate indicator worsened and, in May, most leading indicators showed this decline getting worse, affected by the economic uncertainty, particularly due to the euro area crisis. The economy is therefore likely to continue slowing down in the second quarter or even decline slightly. We have kept to our forecast of 0.1% growth for the whole of the year.
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However, the formation of a new government in May after the victory of the presidential candidate from the socialist party, François Hollande, more inclined towards relaunching the economy, could lead us to revise our forecast upwards. However, the outcome of June's legislative elections will affect economic policymaking. On the other hand, François Hollande agrees with the targets to reduce the public deficit in the long term, albeit with the proviso that these won't be reached unless the economy grows sufficiently. The problem is that there is little room to manoeuvre due to the existing conditioning factors.
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French manufacturing entrepreneurs expect investment to grow by 6% this year.
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Returning to the GDP figures for the first quarter, the zero quarter-on-quarter growth was due to the negative contribution of one tenth of a percentage point by the foreign sector, offset by a contribution by domestic demand of equal size but in the opposite direction. The component that increased the most quarter-on-quarter was public consumption, which speeded up before the presidential elections and rose by 0.5%. Private consumption increased more moderately, by 0.2%, while investment fell notably.
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Moody's keeps its top rating for French sovereign debt but with a negative outlook.
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Within this context, employment in the private non-agrarian sector increased slightly by 0.1% in the first quarter after two consecutive quarters of job losses, standing at the same level as a year earlier. On the other hand, inflation started to fall again in April, reaching 2.1% year-on-year. In this way, consumer confidence picked up slightly in April but is still slightly below its normal level. With regard to investment, in the second quarter industrial capacity utilization relaxed to some extent and sharpened its deviation from the historical average. In April, manufacturing entrepreneurs revised downwards by one point the increase in their expansion expected for 2012 to 6%, compared with January's previous surveys.
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From the point of view of supply, the panorama is similar. Manufacturing production was up by 1.4% month-on-month in March after contracting in February. Orders rose by 1.6% in the first quarter compared with the three previous months and posted a 0.7% increase year-on-year. In April the activity of the secondary sector looked rather stable, as the decline in automobiles, metallurgy and rubber was offset by the progress made in other branches. With regard to construction, demand for new homes weakened in April to a level considerably below the long-term average.
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With regard to the risk premium for French sovereign bonds compared with German bonds at ten years, on 17 March this reached an annual peak at 153 basis points but was below the record of 189 points recorded in November 2011, and at the end of the fourth week in May fell back to a lower level on the eve of the presidential elections, which was also lower than at the start of the year, in spite of tensions in the euro area. On 24 May, Moody's decided to keep its top rating for French sovereign debt although it still gave it a «negative outlook» due to the euro area's difficult economic climate.
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Regarding companies, their number increased by 0.8% in the period of February-April compared with the same period the previous year, indicating that the French economy is fundamentally strong. On the other hand, credit to non-financial firms continued to slow up in March, with a year-on-year rise of 4.0%.
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Italy
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The recession gets deeper in Italy
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In spring, Italy's leading indicators continue to get worse.
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As was expected, Italy saw a considerable drop in its GDP in the first quarter, namely 0.8%, higher than the one recorded in the last two quarters. This suggests that the recession is biting deeper and shows just how deep. The year-on-year rate of change in GDP therefore fell to -1.3%. This contraction in the level of the activity can be explained by the effect of rigorous budget policies, financial tensions and the world economic slowdown. In spring, leading indicators continue to get worse. We have not varied our forecast of a 1.5% drop in GDP for the whole of 2012.
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Consumption, affected by less disposable income, the bad performance of the labour market and continuing inflation, looks weak. April's automobile sales recorded a drop of 18.0% compared with the same month last year. Consumer confidence continued to fall in May to its lowest level for the last few decades. In fact, employment fell by 0.2% in March, seasonally adjusted, compared with February and showed a year-on-year decrease of 0.4%. At the same time, the unemployment rate rose to 9.8% and the number of unemployed increased by 23.4% compared with twelve months before. For its part, inflation held steady at 3.3% in April for the third consecutive month, due partly to tax hikes and higher official prices.
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Italy's consumer confidence slumps to its lowest for the last few decades.
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However, not everything is negative. Over the last three months up to April, exports to countries outside the European Union posted a rise of 2.6% compared with the three previous months, while imports only rose by 0.5%. Similarly, in April sales to non-EU countries were up 2.3% on the same month in 2011, compared with a fall of 8.1% in purchases from this group of countries. It therefore seems as if the foreign sector will be able to continue compensating, albeit only partially, the slump in domestic demand.
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The foreign sector offsets the slump in domestic demand but only partially.
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From the point of view of supply, of note is the fall in industrial production in the first quarter. However, in March industrial orders were up 3.5% month- on-month, although they were 14.3% lower than twelve months before. The deterioration in confidence in the secondary and tertiary sector in April did not leave much room for optimism in the short-term from the point of view of supply either. However, the already approved structural reforms, such as liberalizations and administrative simplification, as well as the proposed changes such as labour reform, will noticeably improve the Italian economy's growth potential.
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On the other hand, in mid-May the differential between yields of Italian and German sovereign bonds at ten years came close to 450 basis points a relatively high level, affected by contagion from the Greek crisis. However, this then fell again slightly. In any case, this level is slightly lower than the 530 basis points recorded in January and the record of 550 reached in November 2011. This improvement is due to the market acknowledging the government's budget consolidation measures, presided over by Mario Monti, although also to intervention by the European Central Bank.
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United Kingdom
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The United Kingdom: readjustment in the economy
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The United Kingdom enters into recession.
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The United Kingdom is continuing its delicate balancing act between declining public and private consumption and stimulating investment and exports and drivers of growth. This process is slow and painful, as highlighted by the figures for gross domestic product (GDP) for the first quarter of 2012. This fell by 0.2% quarter-on-quarter and is the second consecutive quarter of negative growth, because the fourth quarter last year recorded a fall of 0.3%. The economy of the United Kingdom has therefore technically entered recession, although the year-on-year growth rate for GDP has yet to enter negative terrain, standing as it does at 0.0%.
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Leading indicators point to a moderate improvement in economic activity.
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There is no breakdown available of the GDP figures by item of expenditure but there is one by economic sector. Although the data are preliminary and subject to revision, it seems that the construction industry was the main culprit in this fall, down 3.0% quarter-on-quarter, its largest drop since the first quarter of 2009. Manufacturing shrank by 0.1% while services grew by a slight 0.1%, boosted by the sector of transportation, storage and communication.
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From the point of view of demand, household consumption is still weak, as shown by the figures for retail and consumer goods in April, down 2.3% month-on-month and taking the year-on-year rate to 0.4%, this being the lowest growth since January 2010. As well as households being careful with their spending there is an additional factor as sales were hindered by the rain, with April registering the largest rainfall for the month since records began in 1910, according to the country's meteorological office. This factor affected purchases of clothes and petrol, down 5.2% and 3.4% in year-on-year terms, respectively.
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Part of the lethargy in household consumption can be explained by the weak labour market and the deterioration in disposable income for households, as wages are still growing less than inflation and have been for the last four years. Fortunately, the latest inflation figures have been positive insofar as April's consumer price index slowed up, reaching 3.0%, with the previous month recording a rate of 3.5%. We must remember that inflation peaked in the United Kingdom at 5.2% September last year due to the higher energy prices and hikes in indirect taxes. The price index should therefore fall over time due to base effects. The very weakness in demand should also help as it eliminates part of the price fixation power of firms, which need to give discounts and special offers to avoid a greater fall in sales.
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In emerging Europe, while Poland and Slovakia are handling the crisis better, Hungary, the Czech Republic and Romania are suffering more.
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The central government is continuing with its austerity programme, as highlighted by the fiscal deficit figures in April, the start of the tax year in the United Kingdom. Specifically, the deficit stood at 16.5 billion pounds sterling when experts expected this to be higher than 20 billion pounds. The target for the tax year, according to the country's budget, is a deficit of 6.4% of GDP.
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From the point of view of supply, industrial production contracted in April by 0.3% month-on-month and -2.6% year-on-year. However, it's interesting to note the data from the purchasing managers' indices (PMI) both for construction and services, which are at 55.8 and 53.3 points. In both cases they have been above 50 points since the start of the year, a level that indicates expansion of the sector. These data on the economic situation point to moderate growth and suggest that the GDP figures for the first quarter might be revised upwards.
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In short, the economy of the United Kingdom has fallen back into recession and the Bank of England itself predicts that second quarter GDP will fall slightly due to the holding of the Diamond Jubilee celebrations for Queen Elisabeth II. Nevertheless, the Olympic Games will boost economic activity in the third quarter. However, as we are reminded by the International Monetary Fund in its annual report on the United Kingdom, although the economy is expected to consolidate as the year passes, the risks are still markedly downwards.
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Emerging Europe
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Emerging Europe: at two speeds
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Greater falls in GDP than expected in the first quarter in Hungary and the Czech Republic.
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As the year advances, it seems to confirm that the EU economies of emerging Europe are moving at two speeds, as is also the case of the European Union as a whole. Focusing on the five countries we usually review in this report (Poland, Slovakia, Hungary, Romania and the Czech Republic), the first two are keeping up a slightly faster pace in activity than the last three.
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In fact, with the data of National Accounts system for the first quarter now available, it has been confirmed that Romania has entered into recession, this being defined as two consecutive quarters of quarter-on-quarter falls in gross domestic product (GDP), as its economy shrank by 0.1% in the first three months of 2012 (in the fourth quarter, the fall was 0.2%). The Czech Republic, for its part, has been in this sad state since the third quarter of 2011. Nonetheless, we should note that its rate of descent had been minimal, 0.1% in the third and fourth quarter of 2011, until this got slightly worse in the first quarter of 2012, when the economy shrank by 1% quarter-on-quarter. Lastly Hungary, after not growing in the fourth quarter, posted the worst growth figures of the European Union, with a quarter-on-quarter decline of 1.3%.
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As we already mentioned, on the positive side we find Poland and Slovakia. Although we still don't have the growth figures for Poland, monthly activity indicators point to GDP possibly having grown by 0.5% in the first quarter. Slovakia, for its part, came as a pleasant surprise with a 0.8% increase in these first three months of the year (an identical figure to the one recorded in the last quarter of 2011).
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Slovakia comes as a pleasant surprise and Poland is expected to resist without too much difficulty.
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By way of summary, and lacking details on the components, it can be noted that those economies in recession or almost in recession tend to combine weak domestic demand, procyclical fiscal policy and an appreciable decline in exports. Poland and Slovakia are practically in the opposite situation, with a more relaxed fiscal policy and a more appreciably dynamic domestic demand (particularly in the Polish case).
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What can be expected for the rest of the year? These figures, worse than expected in the case of the Czech Republic and Hungary and better than predicted for Slovakia, without essentially altering the scenario we hold for 2012, have forced us to revise somewhat the cases mentioned. In the Czech Republic, the breakdown of supply components, which is available, provides us with a clue as to the sector that has individually pushed down the forecasts, namely finance. Although there were signs that the financial pressures seen since last November had affected the generation of added value in the sector, the drop exceeded expectations. Nevertheless, we believe that, as suggested by the figures on industrial activity, the stamina being displayed by German demand will be a positive factor in the second quarter. In short, we have revised slightly downwards our growth forecast for 2012, from 0.4% to 0.2%.
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The 2012 growth forecasts for Hungary and the Czech Republic are revised downwards, and upwards in the Slovak case.
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With regard to Hungary, the toll taken on growth for the whole of the year by a weaker first quarter than expected means that the annual forecast must be revised downwards, from a drop of 0.4% to one of 1.0%. Lastly, and in the opposite direction, the unexpectedly good figures for the first quarter from Slovakia suggest that it might end the year above the 1.4% we had predicted to date. Although it's difficult to imagine equally intensive quarter-on-quarter growth as that of the last two quarters, the current inertia should help annual growth to reach around 1.6%. For Romania and Poland we keep to our forecasts, with annual growth of 1.1% and 2.5%, respectively.
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The main risk is still the cycle of weakness deteriorating, due to a worsening of the euro area crisis.
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The main risks to these forecasts coming about are almost exclusive to how the euro area's dual crisis develops, namely economic and financial. Should the recession in the euro area not end by the last quarter of the year, as we predict, or should the situation of financial stress increase slightly (to date, with the exception of Hungary and Romania, the region has remained relatively isolated from events in the peripheral countries of the euro area), the remaining four countries (not including Poland) would probably slide towards the recessionary zone (or deeper recession in the case of Hungary).
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Mitigating the risk of natural disasters to promote stability
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There are two faces to natural disasters and neither of them is friendly. On the one hand is the bitterest face, the one that is irretrievable, none other than the loss of human life. To get an idea of the extent of this drama, we only need to remember that, between 1970 and 2010, natural disasters took away the lives of 3.3 million people.(1) Then there are the material losses which, although costly, can be recovered in the medium and long term. Over the same period of time, it's estimated that nature has caused damage to the tune of 3.2 billion dollars (more than 20% of the United States' nominal GDP).
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The economic impact of a natural disaster, as well as the effort involved in the subsequent recovery work, differs substantially depending on whether it has occurred in a developing or a wealthy country. In general, the impact on emerging countries is much more negative. However, developing countries are only covered by some kind of insurance for 3% of their potential losses, compared with 45% in more industrialized countries.
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In August 2005, hurricane Katrina battered the south and centre of the United States, producing a huge amount of damage in Florida, Louisiana and Mississippi. In spite of its seriousness, this disaster hardly affected the country's potential growth as a whole and things got back to normal within a short period of time. Undoubtedly this was possible thanks to the enormous resources available to the United States. We can find the other side of the coin in many developing countries. For example, the earthquake recorded in Haiti in January 2010 caused huge damage was structural in nature, cutting short the already poor economic growth and making the country almost totally dependent on humanitarian and financial aid provided by the international community. This is not an isolated case as, in general, when a natural disaster occurs in a poor country, external aid, for reasons of solidarity or charity, constitutes the basic pillar to alleviate the damage and subsequently reconstruct the country.
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(1) «Disaster Risk Management: Building a Safe and Resilient Future for All», The World Bank, September 2011.
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In order to improve this situation, important multilateral institutions (such as the World Bank) have worked on developing programmes(2) aimed at providing technical and financial assistance so that those countries more likely to suffer the impact of devastating climate-related phenomena can develop Disaster Risk Management or DRM strategies. The idea is to design instruments that help these countries to protect themselves, at least economically, from events that have been seen as fatal to date but that, with suitable preparation, can be turned into manageable misfortunes.
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The development and implementation of a DRM provides governments with significant economic and social advantages. Firstly, they reduce the public accounts' exposure to the occurrence of a natural disaster, as certain risks are passed on to the international reinsurance markets or capital markets. Secondly, lower fiscal uncertainty improves the environment for authorities to help the population access better social services, as well as developing production infrastructures that can boost growth in the long term. Lastly, governments make sure that, in an emergency situation, they will have immediate access to the necessary funds to provide the population with aid and to rebuild the damaged infrastructures. A brief review of the experiences of two countries as different as Mexico and Malawi can help to clearly illustrate the potential benefits that can be gained from such strategies.
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In 1985 Mexico suffered two earthquakes of 8.0 and 7.5 on the Richter scale, causing more than 10,000 deaths and destroying 100,000 homes. This situation forced the government to reallocate resources that had been aimed at developing public infrastructures to be able to meet the costs of rebuilding the private sector. In order to avoid a similar situation in the future, in 1996 the Mexican government decided to create the Natural Disaster Fund (FONDEN) at the same time as developing an institutional framework aimed at diminishing and reducing the risks associated with natural disasters. In order to achieve its goals, the FONDEN uses several instruments including CAT Bonds (catastrophe bonds). A Cat Bond (see the figure below) is a bond that pays periodic coupons to investors during the bond's life and that covers the sponsor against a number of natural disasters (earthquakes, hurricanes, etc.). If any of the events covered occurs during the life of the bond, the sponsor country retains the principal to finance payments for aid to the population and reconstruction work.
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In 2006, the FONDEN issued CatMex bonds totalling 160 million dollars to transfer the risk of a possible earthquake to international financial markets. This was the first time an instrument of this nature had been issued by a government. In 2009, after the CatMex matured, Mexico decided to diversify its coverage further by issuing parametric bonds maturing in October 2012, along the lines of a programme designed by the World Bank. The amount place was 290 million dollars and demand by investors reached very high levels, with private entities of the stature of Swiss Re and Goldman Sachs taking part. With this issuance, the Mexican government has partly passed on the risk of a climate-related or geological disaster to the market, ensuring pluriannual coverage at a reasonable cost. The appeal for private agents acquiring the bond lies in the possibilities for diversification, as these are assets that do not depend on the economic or financial performance of a government or firm and are therefore uncorrelated with the rest of securities.
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Malawi is other example of a country that has benefitted from disaster risk management strategies. This is a poor nation located in southern Africa, highly vulnerable to drought and where 38% of its GDP depends on agriculture. In 2005 the country had a severe drought that forced the government to allocate 200 million dollars to alleviate the hunger suffered by millions of farmers. Although the international community collaborated with a similar amount, the effects were considerable. As a result of this situation, the government of Malawi, advised by multilateral bodies, developed a strategy to pass on part of the risk to the capital markets and thereby mitigate the negative impact of another similar event on the economy and the government's budget. The main aim was to ensure fast access to funds to help reduce the country's dependence on international humanitarian aid. To this end, the Malawi government bought, in 2008-2009, 2009-2010 and 2010-2011, an index-based weather derivative contract (a six-month put option). This index associates rainfall with the production of corn so that, if this falls below a certain level (10% of the historical average), the contract offers protection for any crops that might be lost. In 2009-2010 the dreaded drought occurred but, thanks to this coverage, the Malawi government received a payment which it allocated to buying corn on the international futures market, thereby ensuring the cost of supply for the country.
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(2) In 2006, the Global Facility for Disaster Reduction and Recovery (GFDRR) was set up. The main mandate of the GFDRR is to collaborate in developing strategic policies aimed at reducing the risk of disaster (DRR or Disaster Risk Reduction) and adaptation to climate change (CCA or Climate Change Adaptation).
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These are simply two experiences of countries that, making use of novel instruments, have managed to partly and effectively pass on the risk of a natural disaster to the international financial and insurance markets. These strategies are clearly not a complete solution but they undoubtedly promote greater stability in public budgets and long-term growth.
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This box was prepared by Eduardo Pedreira
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Financial Markets Unit, Research Department, "la Caixa"
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