Tunisia's Economic Machine
Today I am going to take a look at the birthplace of the Arab Spring, Tunisia. The government in Tunisia has seen remarkable change since 2011, however, the economy has developed some fairly troubling problems. Let’s take a look at the Economic Machine in Tunisia, and see if there are any opportunities in the vibrant and developing nation.
As we always do, I will be looking at the Economy through “transaction-based” approach, which means at the bottom of everything, an economy is just someone selling something and someone buying something. That is it.
As in all posts, I will look at 3 main factors to determine how the Economic Machine is working:
(1) Productivity Growth
(2) The Long Term Debt Cycle
(3) The Short Term Debt Cycle.
Let’s get started!
1. Productivity
Tunisia has one of the highest GDP per capitas in Africa, and a diversified economy agriculture, petroleum, and manufacturing making up much of the economic activity. To begin our analysis we first look at Tunisia’s current Annual GDP Growth Rate, which contracted at 0.30% in the 3rd quarter of 2014.
On average GDP growth rate has been around 1%, with an all time high of around 4.5% or so, and an all time low of around -7.5%. I think that GDP will continue to grow from these levels, and I would look for this number to surpass the 1% trendline before we see any pull back.
Keep in mind, one of my pinnacle beliefs is that movements in GDP growth are typically due to expansions or contractions in credit. So, to really understand where productivity is going you have to examine the debt cycles.
Recessions/depressions don’t occur because a drop in Productivity, as many economists think. They occur because a drop in demand, and that is largely due to a drop in credit creation.
Additionally, the most important thing to keep in mind is that debt can’t grow forever, because eventually people can no longer afford to service the debt. The debt-service payments grow faster than incomes, and you have defaults. That is how we get cycles.
Lets look at the Long Term Debt cycle to clear up the picture a bit.
2. The Long Term Debt Cycle
Long Term debt cycles typically occur over a period of 50-75 years, and are a result of debts rising faster incomes, until you get to a point where people/countries can no longer afford to service their debts, usually because interest rates are low and can’t go any lower.
We look at the Long Term Debt Cycle because the availability of credit(debt) expands spending beyond income levels. And one person’s spending is another person’s income. So, an increase in credit, increases spending, which increases income levels, which increases spending, which increases demand, which increases production, and as production increases so should income levels.
The above events are what cause the long term debt cycle.
This cycle churns and churns, and the bubble inflates and inflates, and everyone is happy. But this cannot go on forever. Eventually debts grow faster than incomes, and debt service payments become too high and people/countries can’t afford to service that debt. That is when the entire thing comes crashing down, and everything works in reverse.
Knowing where a country is in this process, and where it is likely headed, will give you insights as to how certain assets will perform.
To begin, the below chart shows the Government Debt to GDP in Tunisia at 44.38% of GDP, which is low, and shows that the government is conscious of its debt, has it under control, and could increase its debt levels, and thus spending, to propel the economy to grow. This government should also not have any troubles paying its bills. This is a promising chart in my opinion.
Now, lets talk about something very important, and that is deleveraging is the process of reducing debt burdens (i.e., debt and debt service relative to incomes).
Deleveragings typically end via a mix of 1) debt reduction, 2) austerity, 3) redistributions of wealth, and 4) debt monetization.
A depression is the economic contraction phase of a deleveraging. It occurs because the contraction in private sector debt cannot be rectified by the central bank lowering the cost of money. In depressions,
a large number of debtors have obligations to deliver more money than they have to meet their obligations, and
monetary policy is ineffective in reducing debt service costs and stimulating credit growth.
Typically, monetary policy is ineffective in stimulating credit growth either because interest rates can’t be lowered (because interest rates are near 0%) to the point of favorably influencing the economics of spending and capital formation (this produces deflationary deleveragings), or because money growth goes into the purchase of inflation-hedge assets rather than into credit growth, which produces inflationary deleveragings.
Depressions are typically ended by central banks printing money to monetize debt in amounts that offset the deflationary depression effects of debt reductions and austerity.
One could consider Interest Rates in Tunisia to get an idea of the debt service payment picture, which are currently set at 4.75%, and have been rising for the past 2-3 years. That would seem to suggest that central bankers are trying to curb lending and thus spending, and slow down the economy.
With rates at this level, central bankers have plenty of room to lower rates to increase growth in credit, which ultimately spurs growth in the overall economy.
Lets switch to Money Supply (M1) in Tunisia, which has been steadily rising for the last 30 years.
With an increase in the money supply you will typically see an increase in purchases, increased incomes, increased demand, and fast economic growth. The only worry of this increase in spending and demand is of course inflation.
Currently, the inflation rate in Tunisia is at 5%, which is high, and a problem central bankers are trying to deal with presumably by raising interest rates.
Keep in mind the drop in oil prices, and Tunisia is a net oil importer, so that should be good news for the consumer. I just think it is taking some time for the extra money they consumer may now have as a result of lower oil to make its way back into the economy.
Now, debt problems typically occur because financial assets are bought at high prices with credit. Let’s look at Tunisia Stock market to get a general picture of where financial assets are currently.
This chart only stretches back 5 years, but you can clearly see the Tunisian Stock Market has seen some cyclical shifts in that time frame, with peaks around 2010, 2012, and it looks like values are rising to peak levels yet again.
Another key indicator is how much the Government is spending, as the Government is one of the most important aspects of the economy. If the government is increasing its spending, that will increase demand, increased demand leads to increased incomes, which leads to more spending, and eventually an increase in prices.
As seen above, Government spending in Tunisia had been steadily increasing, but has plateaued a bit here. Still, levels are overall high and I don’t see any signs of government spending falling drastically, especially with the problems already exhibited in this economy.
Now, the top of the long term debt cycle occurs when 1) debt service payments are high and/or 2) monetary policy doesn’t spur credit growth.
With Debt to GDP very high, interest rates low, and inflation so low,there are obviously some very serious problems in the Tunisia. Still, I like to take a contrarian view point. You are supposed to sell when people are happy, and buy when people are panicking. People in Tunisia are panicking.
Let’s look at the Short Term Debt Cycle to better understand this economy.
3. The Short Term Debt Cycle
Short term debt cycles occur when you have 1) spending growing faster than 2) the capacity to produce, which then leads to 3) increases in prices (inflation), and that continues until 4) spending is slowed by tightening monetary policy, and that is when a recession happens.
Recessions typically arise from a contraction in private sector debt growth, which is typically the results of central banks tightening (increasing rates) to stave off inflation. If we work that backwards we see that increasing inflation will drive central banks to tighten, which will slow private sector debt growth and bring about a recession.
So, to begin, we want to examine the growth rate in Consumer Spending (money and credit) and Government spending, and see if total spending is growing faster than the growth rate of the capacity to produce.
Below is a chart showing Consumer Spending, which has been increasing for the last decade, and shows no signs of stopping.
More spending means more income and more spending, and the cycle continues.
I would really like to see what Consumer Credit levels are, but could not find any reliable data on that.
As well, when discussing the short term debt cycle, we have to examine whether total spending is growing faster than the growth rate of the capacity to produce, because that leads to inflation, until spending is curtailed by tighten monetary policy, which brings about a recession.
To examine production capacity we look at Industrial Production, which increased 1.62% in September of 2014 (the most recent data available), and seems to be hovering around the 2.2% average.
At these levels, I think spending is growing faster than the capacity to produce, which is one of the reason we are seeing higher than average inflation, and also why we are seeing tightening monetary policy (raising interest rates).
Lets pull it all together.
Conclusion:
So the recent growth numbers were not great, we have high inflation and a central bank that is raising rates to, presumably curb inflation. Consumer spending is high, but Government spending and credit are low, and government spending is a huge driver of economic growth in any country.
Personally, when I look at everything above, I think that Tunisia is in the “Late-Cycle”, which typically begins about 2.5 years into expansion, depending on how much slack existed in the economy at the last recession’s trough)
economic growth picks up to a moderate pace (around 3.5-4%)
capacity constraints emerge
but credit and demand growth are still strong
Inflation begins to trend higher
Growth in consumption rises
inventories typically pick up
interest rates rise
the stock market stages its last advance
inflation-hedge assets (3-month TBill; Oil; Gold) become the best-performing investments
But,I could be totally wrong. What do you think?