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High debt levels make it more difficult for governments to respond aggressively to shocks

High debt levels make it more difficult for governments to respond aggressively to shocks

By Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and former chief economist of the IMF.

CAMBRIDGE – As Mark Twain never said, “It ain’t what you don’t know that gets you into trouble. It’s what you think you know for sure that just ain’t so.” Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change. They will include a growth recession in China, a rise in global long-term real interest rates, and a crescendo of populist economic policies that undermine the credibility of central bank independence, resulting in higher interest rates on “safe” advanced-country government bonds.

A significant Chinese slowdown may already be unfolding. US President Donald Trump’s trade war has shaken confidence, but this is only a downward shove to an economy that was already slowing as it makes the transition from export- and investment-led growth to more sustainable domestic consumption-led growth. How much the Chinese economy will slow is an open question; but, given the inherent contradiction between an ever-more centralized Party-led political system and the need for a more decentralized consumer-led economic system, long-term growth could fall quite dramatically.

Unfortunately, the option of avoiding the transition to consumer-led growth and continuing to promote exports and real-estate investment is not very attractive, either. China is already a dominant global exporter, and there is neither market space nor political tolerance to allow it to maintain its previous pace of export expansion. Bolstering growth through investment, particularly in residential real estate (which accounts for the lion’s share of Chinese construction output) – is also ever more challenging.

Downward pressure on prices, especially outside Tier-1 cities, is making it increasingly difficult to induce families to invest an even larger share of their wealth into housing. Although China may be much better positioned than any Western economy to socialize losses that hit the banking sector, a sharp contraction in housing prices and construction could prove extremely painful to absorb.

Any significant growth recession in China would hit the rest of Asia hard, along with commodity-exporting developing and emerging economies. Nor would Europe – and especially Germany – be spared. Although the US is less dependent on China, the trauma to financial markets and politically sensitive exports would make a Chinese slowdown much more painful than US leaders seem to realize.

A less likely but even more traumatic outside risk would materialize if, after many years of trend decline, global long-term real interest rates reversed course and rose significantly. I am not speaking merely of a significant over-tightening by the US Federal Reserve in 2019. This would be problematic, but it would mainly affect short-term real interest rates, and in principle could be reversed in time. The far more serious risk is a shock to very long-term real interest rates, which are lower than at any point during the modern era (except for the period of financial repression after World War II, when markets were much less developed than today).

While a sustained rise in the long-term real interest rate is a low-probability event, it is far from impossible. Although there are many explanations of the long-term trend decline, some factors could be temporary, and it is difficult to establish the magnitude of different possible effects empirically.

One factor that could cause global rates to rise, on the benign side, would be a spurt in productivity, for example if the so-called Fourth Industrial Revolution starts to affect growth much faster than is currently anticipated. This would of course be good overall for the global economy, but it might greatly strain lagging regions and groups. But upward pressure on global rates could stem from a less benign factor: a sharp trend decline in Asian growth (for example, from a long-term slowdown in China) that causes the region’s long-standing external surpluses to swing into deficits.

But perhaps the most likely cause of higher global real interest is the explosion of populism across much of the world. To the extent that populists can overturn the market-friendly economic policies of the past several decades, they may sow doubt in global markets about just how “safe” advanced-country debt really is. This could raise risk premia and interest rates, and if governments were slow to adjust, budget deficits would rise, markets would doubt governments even more, and events could spiral.

Most economists agree that today’s lower long-term interest rates allow advanced economies to sustain significantly more debt than they might otherwise. But the notion that additional debt is a free lunch is foolish. High debt levels make it more difficult for governments to respond aggressively to shocks. The inability to respond aggressively to a financial crisis, a cyber attack, a pandemic, or a trade war significantly heightens the risk of long-term stagnation, and is an important explanation of why most serious academic studies find that very high debt levels are associated with slower long-term growth.

If policymakers rely too much on debt (as opposed to higher taxation on the wealthy) in order to pursue progressive policies that redistribute income, it is easy to imagine markets coming to doubt that countries will grow their way out of very high debt levels. Investors’ skepticism could well push up interest rates to uncomfortable levels.

Of course, there are many other risks to global growth, including ever-increasing political chaos in the United States, a messy Brexit, Italy’s shaky banks, and heightened geopolitical tensions.

But these outside risks do not make the outlook for global growth necessarily grim. The baseline scenario for the US is still strong growth. Europe’s growth could be above trend as well, as it continues its long, slow recovery from the debt crisis at the beginning of the decade. And China’s economy has been proving doubters wrong for many years.

So 2019 could turn out to be another year of solid global growth. Unfortunately, it is likely to be a nerve-wracking one as well.


Copyright: Project Syndicate, 2019.
www.project-syndicate.org


 

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Sanlam 2018 Annual Results

7 March 2019

 

Sanlam’s 2018 annual results provides testimony to its resilience amid challenging operating conditions and negative investment markets

Sanlam today announced its operational results for the 12 months ended 31 December 2018. The Group made significant progress in strategic execution during 2018. This included the acquisition of the remaining 53% stake in SAHAM Finances, the largest transaction concluded in the Group’s 100-year history, and the approval by Sanlam shareholders of a package of Broad-based Black Economic Empowerment (B-BBEE) transactions that will position the Group well for accelerated growth in its South African home market.

Operational results for 2018 included 14% growth in the value of new life insurance business (VNB) on a consistent economic basis and more than R2 billion in positive experience variances, testimony to Sanlam’s resilience in difficult times.

The Group relies on its federal operating model and diversified profile in dealing with the challenging operating environment, negative investment markets and volatile currencies. Management continues to focus on growing existing operations and extracting value from recent corporate transactions to drive enhanced future growth.

The negative investment market returns and higher interest rates in a number of markets where the Group operates had a negative impact on growth in operating earnings and some other key performance indicators. This was aggravated by weak economic growth in South Africa and Namibia and internal currency devaluations in Angola, Nigeria and Zimbabwe.

Substantial growth in Santam’s operating earnings (net result from financial services) and satisfactory growth by Sanlam Emerging Markets (SEM) and Sanlam Corporate offset softer contributions from Sanlam Personal Finance (SPF) and Sanlam Investment Group (SIG).

Key features of the 2018 annual results include:

Net result from financial services increased by 4% compared to the same period in 2017;

Net value of new covered business up 8% to R2 billion (up 14% on a consistent economic basis);

Net fund inflows of R42 billion compared to R37 billion in 2017;

Adjusted Return on Group Equity Value per share of 19.4% exceeded the target of 13.0%; and

Dividend per share of 312 cents, up 8%.

Sanlam Group Chief Executive Officer, Mr Ian Kirk said: “We are satisfied with our performance in a challenging operating environment. We will continue to focus on managing operations prudently and diligently executing on our strategy to deliver sustainable value to all our stakeholders. The integration of SAHAM Finances is progressing well. In addition, Sanlam shareholders approved the package of B-BBEE transactions, including an equity raising, at the extraordinary general meeting held on 12 December 2018. Our plan to implement these transactions this year remains on track.”

Sanlam Personal Finance (SPF) net result from financial services declined by 5%, largely due to the impact of new growth initiatives and dampened market conditions. Excluding the new initiatives, SPF’s contribution was 1% down on 2017 due to the major impact that the weak equity market performance in South Africa had on fund-based fee income.

SPF’s new business sales increased by 4%, an overall satisfactory result under challenging conditions. Sanlam Sky’s new business increased by an exceptional 71%. Strong growth of 13% in the traditional individual life channel was augmented by the Capitec Bank credit life new business recognised in the first half of 2018, and strong demand for the new Capitec Bank funeral product. The Recurring premium and Strategic Business Development business units also achieved strong growth of 20%, supported by the acquisition of BrightRock in 2017. Glacier new business grew marginally by 1%. Primary sales onto the Linked Investment Service Provider (LISP) platform improved by 5%, an acceptable result given the pressure on investor confidence in the mass affluent market. This was however, offset by lower sales of wrap funds and traditional life products.

The strong growth in new business volumes at Sanlam Sky had a major positive effect on SPF’s VNB growth, which increased by 7% (14% on a comparable basis).

Sanlam Emerging Markets (SEM) grew its net result from financial services by 14%. Excluding the impact of corporate activity, earnings were marginally up on 2017 (up 8% excluding the increased new business strain).

New business volumes at SEM increased by 20%. Namibia performed well, increasing new business volumes by 22% despite weak economic conditions. Both life and investment new business grew strongly. Botswana underperformed with the main detractor from new business growth being the investment line of business, which declined by 24%. This line of business is historically more volatile in nature.

The new business growth in the Rest of Africa portfolio was 68% largely due to corporate activity relating to SAHAM Finances, with the East Africa portfolio underperforming.

The Indian insurance businesses continued to perform well, achieving double-digit growth in both life and general insurance in local currency. The Malaysian businesses are finding some traction after a period of underperformance, increasing their overall new business contribution by 3%. New business production is not yet meeting expectations, but the mix of business improved at both businesses.

SEM’s VNB declined by 3% (up 6% on a consistent economic basis and excluding corporate activity). The relatively low growth on a comparable basis is largely attributable to the new business underperformance in East Africa.

Sanlam Investment Group’s (SIG) overall net result from financial services declined by 6%, attributable to lower performance fees at the third party asset manager in South Africa, administration costs incurred for system upgrades in the wealth management business and lower earnings from equity-backed financing transactions at Sanlam Specialised Finance. The other businesses did well to grow earnings, despite the pressure on funds under management due to lower investment markets.

New business volumes declined by 13% mainly due to market volatility and low investor confidence in South Africa. Institutional new inflows remained weak for the full year, while retail inflows also slowed down significantly after a more positive start to the year. The international businesses, UK, attracted strong new inflows (up 57%).

Sanlam Corporate’s net result from financial services increased by 4%, with the muted growth caused by a continuation of high group risk claims experience. Mortality and disability claims experience weakened further in the second half of the year, which is likely to require more rerating of premiums in 2019. The administration units turned profitable in 2018, a major achievement. The healthcare businesses reported satisfactory double-digit growth in earnings, while the Absa Consultants and Actuaries business made a pleasing contribution of R39 million.

New business volumes in life insurance more than doubled, reflecting an exceptional performance. Single premiums grew by 109%, while recurring premiums increased by a particularly satisfactory 56%.

The good growth in recurring and single premium business, combined with modelling improvements, supported a 64% (71% on a comparable economic basis) increase in the cluster’s VNB contribution.

Following a year of major catastrophe events in 2017, Santam experienced a relatively benign claims environment in 2018. Combined with acceptable growth in net earned premiums, it contributed to a 37% increase in gross result from financial services (41% after tax and non-controlling interest). The conventional insurance book achieved an underwriting margin of 9% in 2018 (6% in 2017).

As at 31 December 2018, discretionary capital amounted to a negative R3.7 billion before allowance for the planned B-BBEE share issuance. A number of capital management actions during 2018 affected the balance of available discretionary capital, including the US$1 billion (R13 billion) SAHAM Finances transaction. Cash proceeds from the B-BBEE share issuance will restore the discretionary capital portfolio to between R1 billion and R1.5 billion depending on the final issue price within the R74 to R86 price range approved by shareholders.

Looking forward, the Group said economic growth in South Africa would likely remain weak in the short to medium term future, and would continue to impact efforts to accelerate organic growth. The outlook for economic growth in other regions where the Group operates is more promising. Recent acquisitions such as the SAHAM transaction should also support operational performance going forward.

“We remain focused on executing our strategy. We are confident that we have the calibre of management and staff to prudently navigate the anticipated challenges going forward,” Mr Kirk concluded.

Details of the results for the 12 months ended 31 December 2018 are available at www.sanlam.com.