The year 2016 was marked by a highly mixed and volatile international environment in the world’s main financial areas, with divergent central bank action that in some cases reduced the monetary stimulus to financial systems, such as the Federal Reserve’s stance in the United States, while in Europe the extension of the expansionary monetary stance characterized the position of the European Central Bank (ECB). In many emerging countries, inflationary pressures were countered with increases in interest rates and currency devaluations.
As for the European area, confidence is struggling to return to pre-crisis levels (with a weak recovery in investment, both public and private), while inflation remains on a negative path with core inflation falling and below 1% owing to low commodity prices and weak consumption, although slight signs of recovery in the 4th Quarter buoyed confidence somewhat. In this context, the ECB strengthened its expansionary monetary action through a series of initiatives:
1) a reduction of 0.40% in the interest rate on its deposit facility; 2) setting the refinancing rate at 0% and that on the marginal lending facility at 0.25%; 3) expanding the asset purchase program to €80 billion per month until March 2017 and extending its scope beyond public sector securities to include private non-financial issues, with a reduction to €60 billion until the end of the year in order to ensure the supply of liquidity to the system. The ECB therefore confirms an expansionary policy, emphasizing how these measures are still needed to ensure that the rise in inflation is stable and long-lasting. In this environment, tensions persist in the banking sector, due both to the weakness of bank balance sheets and gross income eroded by low interest rates, with the Italian banking industry among the hardest hit. The low profitability of the system (owing to interest rates at zero) and the low efficiency in cost management (cost/income ratios are still high) exacerbate the already delicate financial condition of the banks.
In Italy the ratio of NPL/CET1, i.e. bad debts to pure equity, is 150% on average, the highest in Europe and not sustainable in the long run. This is intrinsic to the bank’s focus on domestic business, which has been struggling in a sluggish economy. However, banks are well capitalized, with a mean value for CET1 of 12.3% (above the Basel III requirements).
The 1st Half of the year ended with a very important event, one whose economic and political consequences are still difficult to assess. In a referendum held on June 24 last year, the United Kingdom decided to leave the European Union, with major economic indicators remaining positive but volatile (prices, employment and PMI index rising), with a temporal shifting of investments that has not yet materialized. Until Article 50 is invoked (and trade agreements then reached with Europe), it will be difficult to quantify the impacts in terms of postponed investments and reduced consumption. The Bank of England recently cut its official rate by 25 basis points, expanding its program for injecting liquidity into the economy in response to uncertainty about the macroeconomic situation. As for the United States, growth figures and the performance of the labor market have continued to improve in recent months, with inflation remaining close to the target level of 2%. The elections of 8 November represented a political discontinuity, as Trump’s agenda will likely have a different focus from that of the previous administration regarding domestic industrial strategy, energy policy and trade agreements. Fears of a Chinese hard lending, which loomed especially large in the early months of the year, together with low commodity prices, the associated impact on emerging countries and the uneven performance of the real economy prompted a delay in any increase in US interest rates and a steady appreciation of the US currency. In December, moving in the opposite direction of European monetary policy, the Federal Reserve made its first rate increase (25 basis point). The emerging evidence points to further rises in the course of 2017, but with great attention to macroeconomic data, which will determine the size and timing of monetary policy actions.
The macroeconomic environment created severe strains in the financial markets in 2016, characterized by losses for the main equity indices (especially in Europe and Japan, although the latter posted gains in the 4th Quarter), based on expectations of downward revision of per-share earnings in the major segments and an increase in investor risk aversion, with purchases focusing on safe haven assets such as the yen, the Swiss franc, gold and German and Japanese government securities (whose yields even turned negative).
Last February the Bank of Japan (BoJ) decided to introduce negative interest rates on deposits in an attempt to further stimulate lending to the private sector and thus sustain investment, supporting growth and above all inflation, which remains negative.
The situation is different in Latin America, which at the end of 2015 – with an economy already in trouble – had to cope with the impact of “El Niño“, which caused flooding in Argentina and Chile and drought and high temperatures in Brazil. In 2016, Latin American economies struggled with high inflationary pressures and growth rates that were low and falling compared with recent years. In Argentina, inflation accelerated faster than expected in the 3rd Quarter to 42%, before easing again in the 4th Quarter of the year.
The Government is working to limit the month-on-month rate of increase and return it to target levels, which will be implemented starting in 2017 (12-17% for 2017 and 8-12% for 2018). The removal of restrictions on foreign currencies produced a devaluation of the peso, normalizing the foreign exchange market in order to provide new fuel for the engine of growth, with a focus on exports and investment. The measures adopted by the Macri Government to stabilize the economy not yet had a real impact on inflation, while at the same time the country is also experiencing a recession that lasted for more than 15 months. Brazil registered inflation of 8.7% year on year, due to rising prices for agricultural goods and unprocessed foods, but it is trending down slightly. Unemployment remains a major issue, at levels close to 12%, and the economy continues to contract, albeit at a slower pace than in 2015.
Chile is going through a contentious period. The unexpected price increase in the first part of the year (as a result of the prices of food products and transport costs) reflected inflation that was failing to converge towards the target level of 3%, although it did improve at the end of the year, closing 2016 at 4.8% year on year. However, the Monetary Policy Committee (MPC) continued to maintain a neutral monetary stance during the year, but it emphasized the growing need for stimulus in the face of a deterioration in general conditions. Industrial activity recovered somewhat in the final months of the year, but contracted by 2.8% year on year. Even the labor market remained weak, with unemployment worsening at the end of the year. Peru’s monetary strategy is similar to that of Chile, with rates unchanged at 4.25% since March, but in a different macroeconomic environment, which was especially positive in 2016. Economic indicators (with GDP up 3.9% year on year) confirm solid growth. Inflation, which was up slightly in the 4th Quarter, remained stable at around 3.6%, down from 4.6% last January. Conditions are different in the Colombian macroeconomic environment, where economic growth slowed steadily over the year. Inflation rose out of control until July (the highest value in the last 16 years at +8.6%, and +8% on an annual basis), before reversing course, especially in the 4th Quarter, recording an annual increase of 7.5%, far the target level (3%). This year will see the launch of a tax reform that includes a 3 percentage point increase in VAT in order to increase revenue and reduce the risk of a debt downgrade.
The impact of the slowdown have been transferred in part in the form of decline in inflation at the end of the year. In response to these macroeconomic developments, the Monetary Policy Committee has decided to maintain a restrictive stance, keeping interest rates unchanged after raising them in the 3rd Quarter.
In Russia, inflation continued to decline during 2016 and is expected to register an annual increase of 7.1%, falling below the threshold of 7% in the 4th Quarter, due to the limited increase in the prices of services. However, developments in food prices (which are displaying persistent growth) and the effect of the potential weakening of the ruble against the dollar must be monitored. Preliminary figures point to a decrease of 0.2% in GDP in the 4th Quarter and 0.6% year on year, continuing to reflect weak consumption and the decline in investment, in addition to weak exports, which are expected to post year-on-year growth of 0.5%.
The following table shows the growth rates of GDP in the main countries in which Enel operates.
Annual real GDP growth
Source: National statistical institutes and Enel based on data from ISTAT, INE, EUROSTAT, IMF, OECD and Global Insight.
International commodity prices
In 2016 oil prices were affected by high volatility, rising from the lows registered in the early part of the year of $30 a barrel to highs of more than $50.
The causes of the sharp fluctuations, first downward and then upward, were multiple: 1) a decline in growth forecasts for China and the United States (in the initial months of the year); 2) a strong increase in net speculative positions; 3) several unexpected disruptions of production; and 4) the agreement reached in the November OPEC meeting at which the member countries committed to take coordinated action to cut global production of crude oil.
Prices were initially driven mainly by market sentiment, and then by the decline in non-conventional drilling in the United States. Since June the prices remained in the range of $4050 per barrel, reflecting the recovery of shale oil drilling and the subsequent rumors of a possible agreement at the September OPEC meeting.
Volatility then increased in the run-up to the Vienna meeting of November 30, when the major oil producing countries reached an agreement to reduce global production by 1.2 million barrels a day, joined by non-OPEC countries with a further cut of 0.6 million barrels a day. This triggered a rise in prices to more than $50 a barrel, consolidating the upward trend in prices from the lows of earlier in the year.
The main developments affecting coal in the past year were closely linked to events in China, where government measures taken last winter first sought to reduce local production and then to increase it, ultimately generating considerable turbulence on the market, which saw prices double from the lows of around $40/metric ton in February.
All three major benchmarks (API2, API4 and API3) experienced a rapid and constant rise after the weak start of the year in conjunction with the lows registered in oil prices, driven by a sharp increase in Chinese imports (about 80% year on year) due to the concomitant weakness of local production.
The European market, affected by constant oversupply, remains less strained than the Pacific basin as a result of especially weak demand for coal from the power sector. Gas demand in Europe rose slightly over the course of 2016 (about 1.0% year on year), although it is still well below precrisis levels, reflecting a recovery in gas consumption in the electricity sector.
Especially cold temperatures on the European continent provided further impetus to the growth of demand in the residential sector. Supply increased (more than 1% year on year), mainly due to the increase in supplies from Russia, which were needed to offset the impact of maintenance work at the Rough storage facility, and from Algeria, whose gas was mainly directed to Italy. As a result, the European TTF price, after holding at €12-14/MWh in the first nine months of the year, experienced a sharp rise in conjunction with the start of the winter season, increasing to nearly €20/MWh. Italy registered a slight contraction (0.3%) in demand in 2016 after increases caused by the high level of use of gas-fired generation plants in the summer. The only sector that saw an increase in gas consumption was thermoelectric generation, with the greater competitiveness of gas over coal again the main factor.