Friday, October 31, 2014

31/10/2014: Eurocoin Falls Again in October

Meanwhile, in the vastly-repaired, improvingly-coordinated, enhancely-harmonised Euro area, leading growth indicator, Eurocoin (published by Banca d'Italia and CEPR) posted another (4th consecutive monthly decline in October, falling from massively anaemic 0.13 in September to even more anaemic 0.08 in October.

The projected underlying GDP growth rate is now back at zero, having posted a 'recovery' to 0.1% in Q3 2014.

And the ECB is now even more stuck in the proverbial dark corner of near-deflation, zero growth and zero interest rates:

The drivers to the downside?

Industrial production is down across all Big 4 economies:

Business Confidence is down everywhere, save in Spain:

Consumer surveys down in performance terms everywhere and below zero on balance in France and Italy:

With stock markets performance markedly deteriorating, this means the only previous consistent support for 'growth forecasts' is also gone:

And the 'exports-led' recovery is just... err... shall we say 'fizzled out'?

But keep reminding yourselves, this is a 'European Century'...

Wednesday, October 29, 2014

29/10/2014: ABN AMRO on Emerging Europe's Economic Woes

ABN AMRO gloomy outlook for Emerging Europe region came out yesterday. Here are some highlights as related to Russian economy:

Over the past months, emerging Europe has increasingly faced headwinds.

Two core factors selected by ABN AMRO for these: Russian economy weaknesses and "weaker-than-expected performance of the eurozone, emerging Europe’s main trading  partner". In particular, "this can for instance be seen in Poland, where exports to the EU have slowed noticeably".

"All in all, according to our emerging Europe GDP tracker, annual growth in the region  fell to 1.1% yoy in Q3, down from 1.3% in Q2, keeping it on a downward path. Within the region, despite its structural outperformance over the past years, the Polish economy seems to be  slowing the most, while growth in the Czech Republic and in Hungary seems to be a bit more resilient."

"Looking further out, though risks remain tilted to the downside, growth should pick up next year. This reflects that we think that somewhere down the road, both Russia and Ukraine should recognise that some form of a diplomatic solution is needed. Alternatively, the conflict could evolve to a ‘frozen conflict’ with fewer economic consequences than currently is the case."

ABN AMRO sees this set of factors giving "room to a slight rebound in Russian GDP growth, though the slide in oil prices poses yet another headwind."

Here's their more detailed analysis for Russia:

And worse for Ukraine:

Tuesday, October 28, 2014

28/10/2014: US News & WR: Global University Rankings

US News & World Report published their first global Universities rankings:

And the numbers are pretty much disastrous for Ireland:

No Irish University in top 100. No Irish University in top 1-199. Best ranked Irish university is 210th (TCD). Only one Irish university in top 250. Only two Irish universities in top 300. Only 3 Irish universities in top 500...

Here are the 'neighbourhoods' for TCD:

 For UCD:
 And for UCC:

Nothing else to comment...

See other rankings links here:

28/10/2014: Buffett’s Magic: Cheap Leverage and Risk Control

My new post on Warren Buffett's investment 'style' is available on

Monday, October 27, 2014

28/10/2014: Page 75... ECB Washes Out Its Big Bazooka QE with New NPLs...

In the previous (lengthy) post I covered my view of the ECB stress tests results. But, per chance, you have missed two core points on these, here they are, in a neater summary:

Point 1: Stress tests are weak compared to expectations and independent analysts' estimates of capital shortfall (by a factor of up to or in excess of10:1).

Point 2: Stress tests have raised non-performing loans levels in the euro area banking system by EUR136 billion to EUR879.1 billion or close to 9% of the euro area GDP. The increases were recorded in all categories of loans, which in simple terms means the banks have been under-providing for loans losses across all categories of their core assets.

Now, that puts into perspective the ECB's 'big game all-in' shot for TLTROs and ABS purchases targeting to raise ECB balancesheet exposures by... you've guessed it... EUR1 trillion.

Why, despite improving asset markets, stoic rhetoric of deleveraging and historically low cost of central banks' funds, the NPLs are climbing... and by the end of the ECB's big bazooka firing, that EUR1 trillion is probably will be just about enough to cover the outstanding NPLs. Assuming economy does not tank any more, in which case, it might fall short.

Update: Here's WSJ Blogs analysis of the effects application of the tougher quality tests for Core Tier 1 capital would have had on ECB stress test results:

Sunday, October 26, 2014

26/10/2014: Mind the ECB 'Stress Tests' Gap

The pain of European economy's Japanification is going to be proportionate to the cheering of the ECB 'stress tests' results.

The real problem faced by European economy is that of the depressed domestic demand (investment and consumption). This problem is fuelled by:
1) declining real incomes of those working,
2) continued sky-high numbers of those who are not working (unemployed, discouraged and never-once-employed workers left out in the cold),
3) growing unease amongst older workers about the state of their pensions,
4) rising burden of the state (including state debts),
5) growing pressure of redistribution of income from households and SMEs to politically favoured white elephant projects (e.g. renewables subsidies, large infrastructure spending, farm supports, regional integration etc),
6) un-abating waste at the EU and national levels anchored to corporatist politics selectively rewarding specific interest groups interests at the expense of entrepreneurs, younger workers, ordinary households and domestic firms, and
7) demographic collapse spreading across the continent as populations age and children remain dependent on ever older parents to support their education and transitioning into joblessness.

This real problem is driving down domestic demand, and with it depressing economy, but also spreading rot across the banks balance sheets.

And yet, despite the obvious and ever-deepening macroeconomic crisis of depressed demand, the ECB stress tests released today provide no insight into what can happen to the banks balance sheets should Japanification set in. Worse, the entire exercise of 'stress tests' is once again not much more than a PR stunt dreamed up by the folks who are 'would be' chief economists for the sell-side equity research.

Here's why.

Back in January 2014, two academics published a preliminary assessment of the Euro area banking union capital shortfalls:

This identified stressed shortfalls estimated at between €82 billion and €176 billion (4% benchmark capital ratio) and €509 billion to €767 billion (7% capital ratio) based on book capital.  Take the average to compare to ECB results: ca EUR295-470 billion. "The market capital shortfall estimates indicate a capital shortfall of €230 billion (4% benchmark capital ratio) or €620 billion (7% capital ratio) for the 41 publicly listed banks". Take the average to compare to ECB results: EUR425 billion.

Worse, "estimates of SRISK or the capital shortfall in a systemic financial crisis (40% market decline over a six-month period) is €579 billion; 41% is due to downside correlation with the market, while 59% is due to the leverage of these institutions." So compare to 20% decline under ECB tests (across property assets, 30% decline) and get roughly half of the above figure at EUR290 billion.

Ugly? Try next: "Capital shortfall estimates when writing down their net non-performing loan portfolios range from €232 billion (using the C Tier 1 ratio and an 8% threshold as in the AQR) and €435 billion (using the tangible equity/tangible assets ratio and a 4% threshold)." Again, average these out at EUR330 billion or so.

And get this: "There is a high rank correlation between the shortfalls based on book and market capital ratio measures [but] no significant correlation between shortfalls calculated using regulatory (i.e. risk-weighted asset-based) capital ratios and shortfalls calculated under market or book capital ratios… this highlights how flawed risk-weighted asset-based measures can be."

Take the conclusion in with a deep breath: "Cross-country variation in our capital shortfall estimates indicate that:

  • French banks are leading each book and market capital shortfall measure, both in absolute euro amounts and relative to national GDP. The capital shortfall ranges from €31 billion (using the equity/asset ratio and a 4% threshold) to €285 billion (using the tangible equity/tangible asset ratio and a 7% threshold). The SRISK stress scenario suggests a shortfall of €222 billion, which corresponds to almost 13% of the country’s GDP.
  • German banks are close seconds, although they benefit from a stronger domestic economy with a higher GDP and a greater capacity for public backstops.
  • Spanish and Italian banks appear to have large capital shortfalls when non-performing assets are fully written down. Both countries account for about a third of the total shortfall after write-downs. Market-based measures such as SRISK amount to about 6.5%–7.6% of the GDP of both countries."

So a close common value for estimated shortfalls, comparable to the ECB tests is around EUR290 billion for 41 listed banks (not 150 tested by EBA/ECB).

Oh dear, now think ECB stress tests: The ECB stress tests found virtually none of the above problems to be present or pressing (see full release here: Instead, the ECB tests estimated shortfall in the banks to be EUR24.6 billion as of December 2013 and that all but EUR9.5 billion of this has been already rectified by the banks.

This is plain mad not only because it is more than 10 times the number averaged out above, but also because the same ECB review found that some EUR136 billion of loans held by the banks as assets should be classed as non-performing. That is an 18 percent hike in one sweeping year. 85% of banks tested had to revise up their bad loans exposures. And this implies that EUR47.5 billion worth of losses is required to bring these 'assets' in line with their true values.

These losses will have to be covered from either more tightening of existent loans costs or via capital raising or by shrinking returns on equity or all of the above. And these losses are at the lower (as noted by independent analysts) end of the range. And these losses are going to impact future capital access by the banks too, as who on earth would want to stake a house on investing in sick banks hiding the true extent of their losses to the tune of 18 percent?!

All in, Euro area banks now have a hole of EUR879 billion in non-performing loans, facing losses of some EUR300 billion, plus. Based on already stretched (by extend-and-pretend measures adopted to-date) loss rate on non-performing assets. Oh, dear…

Table below summarises sources of NPL increases by category of assets:

As of the end of 2013, per ECB own assessment, some 1/5 of all major banks were in the position of facing high risk of going bust. Forward nine months into this year - what has changed? Nothing, save for the following factors:

  1. ECB funding became temporarily cheaper (rates down), but LTROs are being replace by higher priced TLTROs and this means cost of funding going slightly up;
  2. Assets valuations have improved on massive monetary stimuli. These being gradually reduced (outside the euro area) is going to depress carry trades that have been helping asset prices boom. Asset values might not fall, but realising these values in the markets forward and counting on their further significant appreciation would be equivalent to taking serious risks.
  3. Real economic conditions have deteriorated. Which is far from being trivial, as in the long run, asset values and availability and cost of funding should start reflecting this reality. Once they start, there'll be pain on balance sheets. 

What are the safety cushions post-ECB tests? Ugh, rather thin. Of 130 banks tested by the ECB, 25 failed, 31 had core capital ratio below 10% - the safety threshold accepted in the markets. 28 more banks were within a 10-11 percent range. Thus, 84 out of 130 banks tested were either in an ICU or on ventilators.

Looking back at the main findings from January 2014 paper by Viral Acharya and Sascha Steffen, what is striking is the position of the German and French banks. ECB found virtually no problems in both countries banking systems (see Table below):

Table: Banks that failed ECB tests

Look at geographic distribution of losses under stressed scenario:

Setting aside the proverbial 'periphery' (and Slovenia) there are virtually no problems in the stress case across the national banking system anywhere, save for Belgium, the Netherlands, and Luxembourg. Even Italian system is within 1 percentage point of the median losses. You have to be laughing, right?

And the above only holds for 57% of all assets of the tested banks. That's right, the AQR exercise did not cover all assets held by the 130 banks tested.

Meanwhile, macroeconomic risks factored in are rapidly becoming not stringent enough. The ECB tests were based on EU Commission forecasts from Q1 2014. Since then, the forecasts have seen consistent downward revisions. Instead of focusing on the risk of deflationary recession and stagnation (Japanification), the risks tested were based on bond markets stress, plus recession.

There is virtually no material deterioration in ECB assessment results for German banks compared to previous tests. How? We can only scratch our heads. In the last 2 years, German economy has gone from moderate growth to slow growth and is heading into stagnant growth.

Emerging markets risks exposures were non-existent in the view of the ECB tests, except via higher interest rates impact spillover from the US (assumed by the ECB). Neither were the risks arising from the global slowdown in trade flows. So here's a kicker, if rates are higher and there is a global slowdown, impact on banks balance sheets will be most likely lower than if rates are low (and with them lending margins), but there is a secular long term growth crisis in the euro area itself. Second order effects will be smaller than first order effects.

All in, the 'stringent' tests carried by EBA and ECB took 150 banks and banks subsidiaries and found that 25 of these were short of EUR24.6 billion in capital: 16.7% of banks failed, average capital requirement per failed bank EUR984 million, average capital required per all banks tested: EUR164 million. Contrast this with 2011 when EBA tested 90 banks, failed 20 of these (failure rate of 22.2% much higher than 16.7% in this round of tests), requiring them to raise EUR26.8 billion in capital which amounts to EUR1.34 billion per failed bank (much higher than ECB stress tests this time around) and EUR298 million per bank tested (much higher than ECB tests). Yet, 2011 tests were labeled a farce by the markets.

Today's tests are no better. If not worse.

Worse because they fail to account for the real risks arising in the Euro area today and worse because they create a false sense of security within the system. Or maybe they do not. In which case the entire exercise is a PR stunt, with ECB having a different and more descriptive picture of what is really happening in the banking sector. Maybe so… in which case, does the whole charade qualify as market manipulation by the soon-to-be super regulators? Take your pick, either the regulators-to-be are wearing rose-tinted glasses, or they are fixing the market. Neither is a pretty option...

26/10/2014: Ireland's trade in goods with BRICS

Summary of the latest trade in goods for bilateral trade between Ireland and BRICS:

Keep in mind: trade balance is what counts in GDP, GNP and GNI calculations. Data above reflects some impact of the Russian counter-sanctions of July 2014.

Friday, October 24, 2014

24/10/2014: Weekly Russian Economy Update

Bofit released some latest data on Russian economy, so here is the summary, with some of additional points by myself.

September economic activity acceleration came as a bit of a surprise.

  • Manufacturing output was up 4% y/y, driven in part by devaluation of the ruble and in part by increased oil refining activity.
  • Defense spending is up 33% y/y in January-September, which also is helping manufacturing orders.
  • Agricultural output is sharply up as harvest hits near-record levels.
  • Consumption is up as retail sales rose 1.7% y/y with non-food sales up 3.5%. Some observers suggest that households are taking out savings to prepare for higher inflation (inflation hit 8.3% in September, sharply up on 8% in August). Since incomes declined in real terms (down to devaluation and inflation), we can assume that this is to some extent true, although banks are not reporting declines in deposits.
  • New car sales shrank 20% y/y in September from 0% y/y in Q1 2014. 
  • But consumption is most likely showing lags relative to the rest of the economy, so we can expect continued deterioration in retail sales into Q1 2015.
  • Decline in fixed capital investment shallowed out by about 2 percentage points, as Bofit notes "thanks to distinctly better development in investment of large energy and transport enterprises than other investment".
  • Meanwhile, construction activity is slowing down from the H1 2014 boom.

Net outcome: the Economy Ministry estimates GDP growth at +0.7 % y-o-y in January–September 2014, with only slight deceleration in the July-September.

This is strong reading, considering some forecasts (e.g. World Bank at 0.5% for 2014). That said, as I noted earlier today, with Central Bank heading into October 31 decision on rates with expected 50-100 bps hike, we might see a sharp decline in the economy in Q4 2014. It would take 0.2% drop in Q4 to get us to WB outlook.

On the other front, everyone who grew tired of focusing on ruble collapse have switched into prognosticating federal budget meltdown on foot of falling oil prices. Yes, Brent fell by a quarter compared to 2014 highs. And Urals followed the trend with prices around USD85/barrel. The chart below (via Bofit) illustrates.

But no, this is not a letdown yet on fiscal side. Here's Bofit analysis: "If the price of crude oil holds at the $85–95 level for a longer time, Russian growth will be much slower than current consensus forecasts predict… Russia’s 2015 federal budget also assumes an average oil price of $100 next year, producing a budget deficit of 0.5 % of GDP. The impact of a lower oil price on Russia’s fiscal balance will still be manageable; the nominal increase in budget revenues from ruble depreciation will in part off-set losses. Prof. Sergei Guriyev estimates public sector finances could withstand an oil price of $80–90 for a couple of years thanks to reserve funds and the weak ruble. Sberbank’s research department has calculated that the current account will remain in surplus next year even if the oil price holds at $85. Export revenues will fall, but also imports will decline substantially on e.g. the weak ruble and impacts from economic sanctions."

How fast Russian imports fall relative to exports? Tough guess, but here's IMF data showing 2009 crisis period:

One thing is clear: the above forecasts by the IMF for 2015 show pretty small reaction in imports. If Russian demand for imports goes negative, it will be down to a number of factors:

  1. Lower ruble leading to imports substitution - which is GDP-enhancing;
  2. Russian sanctions leading to imports substitution - which is GDP-enhancing;
  3. Government contracts shifting to imports substitution (including those with Ukraine, relating to military equipment) - which is GDP-enhancing.

And as 2009 shows, the room for contracting imports is massive: 28.7% y/y in one shot. And IMF is forecasting 2015 decline to be just 0.3% y/y.

24/10/2014: One Ugly with some Ugly Spice... EURO STOXX EPS

It's Friday... ECB is coming up with the banks tests on Sunday... And before then, if you want 'ugly', here's 'ugly':

The above chart plots Earnings per Share, in euro, for S&P500 and for EURO STOXX. It comes via @johnauthers

Now, despite this, you wouldn't believe it, but roughly 68% of European companies reporting earnings this quarterly cycle to-date have been outperforming analysts expectations.

And for some real 'ugly' spice on top of this pizza, the sub-trend decline in the EPS for European stocks has set on roughly H2 2011... something we shall remember when we re-read all the European 'recovery' tripe from 2011 and 2012 and a good part of 2013.

24/10/2014: Behavioural Political Economy

A very interesting survey paper on the topic of behavioural drivers of political economy by Schnellenbach, Jan and Schubert, Christian, titled "Behavioral Political Economy: A Survey" (September 30, 2014. CESifo Working Paper Series No. 4988.

From the abstract:

"Explaining individual behavior in politics should rely on the same motivational assumptions as explaining behavior in the market: That’s what Political Economy, understood as the application of economics to the study of political processes, is all about." So far - fine.

However, there is a problem: "In its standard variant, those who played the game of politics should also be considered rational and self-interested, unlike the benevolent despot of earlier models. History repeats itself with the rise of behavioral economics: Assuming cognitive biases to be present in the market, but not in politics, behavioral economists often call for government to intervene in a “benevolent” way. Recently, however, political economists have started to apply behavioral economics insights to the study of political processes, thereby re-establishing a unified methodology. This paper surveys the current state of the emerging field of “Behavioral Political Economy” and considers the scope for further research."

It is a lengthy and solid review, covering some 41 pages. Dense. But absolutely a great read as an introduction into the subject. 

Thursday, October 23, 2014

23/10/2014: Irish Residential Property Prices: Q3 2014 data

Latest data for residential properties price index for Ireland is out, covering September. Instead of repeating all the analysis provided elsewhere, here is a look at quarterly data series and longer-term comparatives.

Firstly, on quarterly basis, Q3 2014 ended with index averaging at:

  • 79.1 in Dublin, up strongly on Q2 2014 reading of 72.0. This brings property prices to the levels of Q2 2010 or on pre-crisis comparative basis close to Q4 2002 (80.8).  Year on year prices in Q3 2014 stood 23.9% above Q3 2013 reading, which is a modest increase on Q2 2014 y/y increase of 21.2%.
  • Outside Dublin, index read 71.4 in Q3 2014, marking a rise of 5.8% y/y. In Q2 2014, y/y increase was 2.2%. Outside Dublin prices are currently trending at the levels comparable to Q1 2012 (71.2) and on pre-crisis basis - at the levels between Q2-Q3 2001
  • National prices index is at 76.9, up 14.4% y/y and this compares to a rise y/y of 10.6% in Q2 2014. National prices levels are around Q2-Q3 2011 averages and on pre-crisis basis these are up at the levels of Q2-Q3 2002.
Chart to illustrate:

Rates of growth in prices are worrying, as they were for some time now. Chart below shows y/y increases in price indices for quarterly averages:

The chart above clearly shows that Dublin price increases have been running well above the historical averages for the main periods since Q1 2000. Q3 2014 marks full year since price appreciation in Dublin market has risen above sub-period (2013-present) average and this now becoming a serious issue.

At the same time, long-term level indices suggest that prices remain below historical trends:

So once again, data is showing troubling developments in the rate of price increases in Dublin and below-trend price levels. Based on historical evidence, real price bubble concerns are still outside the scope of index readings by some 25-30 percent. But we are closing that gap very fast.

23/10/2014: BlackRock Institute Survey: EMEA, October 2014

BlackRock Investment Institute released the latest Economic Cycle Survey results for EMEA:

"The consensus of respondents describe Russia, Croatia, Egypt and the Ukraine in a recessionary state, with an even split of economists gauging Hungary and Turkey to be in a recessionary or contraction phase. Over the next two quarters, the consensus shifts toward expansion for Egypt and Turkey"

Red dot represents Czech Republic, Kazakhstan, Israel, Poland, Slovenia and Slovakia

"At the 12 month horizon, the consensus expecting all EMEA countries to strengthen or remain the same with the exception of Russia and the Ukraine."

Global: "respondents remain positive on the global growth cycle with a net 43% of 37 respondents expecting a strengthening world economy over the next 12 months – an 7% decrease from the net 50% figure last month. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy"

Previous month results are here:

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

23/10/2014: Euromoney Country Risk survey results Q3 2014

Euromoney Country Risk survey for Q3 2014 is out:

Euro area risks are down, but starting to regain upward momentum in recent weeks. Meanwhile, BRICS are struggling, Russia risks deteriorating and overall global environment is not encouraging.

Tuesday, October 21, 2014

21/10/2014: Two Articles on Ukrainian Conflict

Two items relating to Ukrainian crisis worth noting today.

First an English version of the earlier De Spiegel article on German federal authorities concluding that it was likely that MH17 was shot down by the Eastern Ukrainian separatists using the BUK launcher they obtained from the seized Ukrainian military base: Note: this is still speculative, in so far as we do not have conclusive evidence as to where the BUK came from, nor in fact do we have full evidence on the rest of the event.

Second, Human Rights Watch issued a report: that provides evidence that Ukrainian Government used cluster munitions against civilians in East Ukraine. The report also references on several occasions the potential use of such munitions by the separatists, although in all cases, HRW does qualify such references as not being confirmed. What is confirmed, however, is that Kiev forces used cluster munitions.

21/10/2014: Of Statistics: Ireland and ESA2010

Eurostat released a handy note showing revisions to euro area debt and deficit figures that arose as the result of conversion to ESA2010 methodology (yes, yes, that infamous inclusion of illicit trade and re-classification of R&D spending as investment, and much more).

You can read the full note here:

And the effects are:

Government deficit revisions:
Click on chart to enlarge

One clear outlier in the entire EU28 is... Ireland. We had the largest, by far, downward revision in our deficit/GDP ratio of some 1.5 percentage points, pushing our deficit down from 7.2% of GDP (ESA95) to 5.7% of GDP (ESA2010) overnight. No austerity, just accounting.

We were similarly 'fortunate' on the debt calculations side:
Click on chart to enlarge

While revised actual debt levels rose, under new rules, the revised debt/GDP ratio fell due to GDP push up under the new rules. Lucky charms...

Per note, relating to deficit revisions: "Ireland (-3.1pp for 2010, -0.1pp for 2011, -0.1pp for 2012 and +1.0pp for 2013): the 2010 and 2011 deficits were  revised mainly for other reasons (than ESA 2010 introduction) and the 2012 and 2013 deficits mainly due to  introduction of ESA 2010. The deficit for 2010 was increased mainly due to reclassification of the capital injection  to AIB and the deficit for 2011 due to various reasons such as an adjustment to accrual calculation for PRSI,  health contribution and National Training Levy. The revisions in the deficit for 2012 and 2013 are mainly due to  the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central government. " 

Per note, relating to debt revisions: "Ireland (+12.2pp for 2011, +10.3pp for 2012 and +7.2pp for 2013): the revisions in the debt are mainly due to  introduction of ESA 2010: the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central  government as it became a government controlled financial defeasance structure in 2011."

So our actual debt rose. But our debt/GDP and deficit/GDP ratios fell:

Enron would be proud...

21/10/2014: Russian Gas, European Deliveries, Ukrainian Blackmail?

Over recent days there have been plenty of statements about the winter supplies of Russian gas to Europe. Majority of these fall to one side of the argument, alleging that Russia is likely to cut off gas shipments to Europe via Ukraine.

Here are the facts, strongly indicating an entirely different possibility.

Fact 1: Allegations. At the end of August, Euractive reported that "Europe faces the increasing threat of a disruption to gas supplies from its main provider Russia this winter due to the crisis in Ukraine." (link)

But when you read beyond the headline, you get something entirely different. "Ukrainian Prime Minister Arseny Yatseniuk said today (27 August) Kyiv knew of Russian plans to halt gas flows this winter to Europe. "We know of Russia's plans to block [gas] transit even to European Union countries this winter, and that's why their [EU's] companies were given an order to pump gas into storage in Europe as fully as possible," he told a government meeting, without disclosing how he knew about the Russian plans."

So Yatsenyuk presented a conjecture - that incidentally boost his own agenda. Media reported it with zero questioning. Meanwhile, Russian officials denied the possibility of such disruption: "It's unlikely that Russia would cut gas supplies. Ukraine will start siphon off it itself, as it has been the case in the past," a senior source at the Russian Energy Ministry said."

We have set the stage: Ukraine says Russia may disrupt supplies. Russia says Ukraine may siphon off gas destined for other buyers in order to satisfy its own needs.

Fact 2: Historical Precedents. As Euractive reports: "Russian gas flows to Ukraine have now been halted three times in the past decade, in 2006, 2009 and 2014, due to price disputes between Moscow and Kyiv, and flows to the EU were disrupted in 2006 and 2009 after Ukraine took some of the gas intended for the EU to meet its own winter demand."

In other words, Ukraine stole (as in appropriated without a payment and beyond its contracted power) Russian gas destined for European customers. This, presumably is Russian fault, as it is Russia that is being blamed for the disruptions.

So we have it: Ukraine steals, Russia gets blamed.

Fact 3: Counter-accusations. Official Russian position on supplies of gas to Europe: "Russian Energy Minister Alexander Novak refuted the claim by Ukrainian Prime Minister Arseniy Yatsenyuk that Russia is planning to halt gas transit to EU member states. “Specific comments by Ukrainian politicians on alleged Russian intentions to stop gas transit to EU countries are puzzling. We can qualify them only as absolutely baseless speculations aimed at confusing or deliberately misinforming of European consumers of Russian gas”, said Alexander Novak."

Now, you can possibly say there is risk of Novak lying. Or you can say there is risk PM Yatsenyuk is lying. Remember: Yatsenyuk made a statement of claim unbacked by any evidence (Fact 1 above). Novak made an official statement on the record. Yatsenyuk has an incentive to push European member states to take a tough stance on Russia in brokering a gas deal between Russian and Ukraine. Russia does not have such an incentive. Yatsenyuk is actively campaigning for an outright re-writing of Russian-European contracts for gas supply to suit Kiev interests (read below). Russia does not have such an incentive.

So who is the beneficiary of all these conjectures about Russia 'cutting gas supplies to Europe'? Why, it is Ukraine.

Fact 4: In his own words. On October 17 Itar Tass (link) claimed: "Europe should respond to a statement by Ukrainian Prime Minister Arseniy Yatsenyuk that Ukraine can give no guarantees for safe Russian natural gas transit to Europe, Gazprom Deputy CEO Alexander Medvedev said on Friday. “Yatsenyuk said yesterday that Ukraine will not be able to ensure the safety of gas supplies from Russia to Europe,” he said."

So did Yatsenyuk say this? He did. His statement is supported by his own actions tracing back to end of July / beginning of August.

Fact 5: In his own deeds. Let's go back to August 8th, when Yatsenyuk threatened sanctions to cut off all transit of Russian gas: "Ukraine may impose sanctions against any transit via its territory, including air flights and gas supplies to Europe, Prime Minister Arseniy Yatsenyuk said Friday." (link confirmed by Bloomberg here and the Wire here).

So real was this threat, Germany had to step in to put PM Yatsenyuk back into his place (link). And European buyers continued to pump up storage facilities not because of a Russian threat, but because of the Ukrainian actions.

Things got comical: Naftogas - a Ukrainian state-owned gas company - said back in August it was prepared to bypass its own Government-imposed restrictions on transit (link). So even Naftogas was aware that it was Kiev, not Moscow, who planned the cut off.

20 days after Yatsenyuk backed out the first threat, "Ukrainian Prime Minister Yatsenyuk pushed a bill through the Verkhovna Rada that …would permit the transit of natural gas to be blocked." Source (link). In other words, on August 28, Yatsenyuk pushed through a law that legalises Ukraine's power to shut down transit.

Ukraine was no longer speaking about shutting down Russian gas transit. It actually set legal grounds for acting on doing so.

On September 23rd, Kiev backed out of the month-old stand and committed itself to allowing transit (link). Strangely, the article does not really try to explain why PM Yatsenyuk had to commit to such an act, if it was Russia that was a threat of disrupting gas flows.

Conclusions: Now, we can think of a straight logic implying that actually it is Ukraine that is a threat point replete with threat --> act --> deny chain of events. But the Western media continues to insist that it is all down to Russia's bad politics.

This week (link) Ukraine is again refusing to guarantee uninterrupted transit to Europe unless it gets all Russian-European contracts renegotiated on its own terms. These terms are: Ukraine gets full control over actual gas transiting over its territory and gains a de facto veto power on any contract any European buyer signs with a Russian supplier.

Again, who is the attempting to hold European gas supplies hostage to its own political agendas?

Monday, October 20, 2014

20/10/2014: Ruble: Poisoned, a Touch Less Than Real or NZ Dollar?

Two days ago I wrote about the pains of Ruble devaluations ( and here is an interesting new set of data courtesy of @ReutersJamie which shows positioning in the FX markets. All bearish, except USD, and bearish on Ruble too, but what is interesting is that Brazil Real and NZ Dollar are more bearish... And Ruble, for all its problems is positioned pretty close in line with Euro, which, apparently has no problems (remember, ECB refuses to call this a currency crisis, insisting first it was a debt crisis, now a structural growth crisis, next probably a milk quota crisis):

20/10/2014: Jean Tirole: Master Of Incentives, Risks and Contracts

Last week's Nobel Memorial Prize award in economics went to Jean Tirole. Here are some of my thoughts on his tremendous legacy:

Sunday, October 19, 2014

19/10/2014: IFSC: Down, Down and Down It Goes...

This data has been crowding my desktop for some time now, so might as well post it. In September this year, the new rankings of Global Financial Centres ( came out for the second half of 2014. Dublin slipped to a rather less than honourable 70th place, down 4 ranks from march 2014 and 14 ranks from September 2013.

Here's the chart showing the sorry state of decline in Irish Financial Services prime centre in global position (these are primarily IFSC-linked):

So may be, just may be, having the chair of IFSC going around talking about everything political and EU is not exactly what drives excellence in the international financial services? Any ideas?..

19/10/2014: Dublin: Just 24th in the Global Centres for Talent Rankings

You know the mythology: despite 55% upper marginal tax rate in exchange for nearly zilch in public services, despite the need to pay consultants' fees and private insurance just to get basic medical care, and despite the fact that childcare runs a cost of the second mortgage, Dublin (nay, rest of Ireland too) is a great location for human capital-rich expats, especially if they command high salaries...

And now, we have:

Dublin ranks 24th in the world amongst the locations 'most appealing' for expats.

Never mind, we already have the best educated workforce in the world, so be jealous you London, NYC, Paris, and all the rest of ye in the 23-losers lot.


19/10/2014: Chart of the Week: Japanising Europe

A chart of the week, courtesy of @Schuldensuehner

10 year benchmark bonds: Japan for 1987-2004 period of decline and stagnation and Germany for 2004-present period of decline and ... oh, well... Japanisation of Europe is still ongoing, but it goes without saying: lower yields are not conducive to economic recovery. Or as @Schuldensuehner  noted:

Everything is going according to script...

Now, check out why Germany's lower borrowing costs mean preciously nothing when it comes to the hopes of Keynesianistas around the world for more German borrowing:

19/10/2014: A New Cold War is a Bilateral Culpability

A well-balanced review of history that has led Russia and the West to the current confrontation:

Select quotes:

"In Putin’s world national “sovereignty” is a central principle – but just a few countries can claim sovereignty and, therefore, have the right to a sphere of influence. Russia is one of those chosen few – historically, and because Putin stands ready to fight for his nation’s sovereignty in a world where Might means Right."

"In the twenty-first century, the West responded, all nations are equal and each country is sovereign. This sounds like a wonderful world – except that this does not seem to be the world of the US-led policy of humanitarian intervention, peace enforcement, taking sides in other nations’ domestic conflicts, and killing the forces for evil on behalf of the forces for good. Putin saw this as an argument that his world of Might means Right was real: America could pursue such policies because it was powerful and sovereign."

"The current confrontation between Russia and the West is a move back to a cold war design: Russia as “another world” isolated by the US-led West. Russia’s world today is limited to just itself with no socialist camp around it, and the West has the potential of pushing Russia deeper into a crisis, both economic and political. Unlike the Soviet meltdown that had numerous internal causes, but is blamed on the West by Russian conspiracy theorists, this crisis will truly be precipitated by the West."

19/10/2014: Of National Accounts and Ministerial Declarations

Here's an interesting take on the role of ESA2010 reclassifications on Euro area growth: Strangely, this topic is rarely discussed in Ireland which switched to ESA2010 standards ahead of majority of other countries.

And here's an illustration of the claim by Minister Noonan (made in his Budget 2015 speech) that Irish farming is a EUR26 billion sector:

Somewhere else, someone is producing EUR20 billion worth of 'farming' activity that Minister Noonan knows of... Maybe he or they can point us in that direction. But the above figures include much more than 'farming':

And the above figures include double-counting too, since they come from two different sides of the National Accounts (some of exports are in the Sector Output at factor cost). And they include net subsidies of some EUR1.5 billion (see which no one, save possibly an Irish Minister, can describe as 'activity'. 

Saturday, October 18, 2014

18/10/2014: Irish Economy: The State of Recovery

Yesterday I had a chance to speak about the state of the Irish economy at a breakfast briefing hosted by Invesco. Here are my speaking notes (slightly edited).

Where Ireland is today?

  1. There is a recovery
  2. The recovery is still fragile & highly uneven
  3. Risks to the downside of the recovery continue to weigh heavily: external (international risks) and internal (domestic and structural risks)

There are three ‘Irelands’ today co-sharing this economy.

Ireland of ‘haves’ 

  • Demographically old       
  • Benefited from asset bubble of the 2000s
  • Debt-free and secure in income
  • This Ireland is growing in numbers, but not in terms of value added in the economy: 52,200 more in retirement today than in H1 2011 (+17.9% on H1 2011)
  • This generation no longer saves to invest and is consuming lower value-added goods and services, which are lower in growth intensity

Ireland of ‘hopes’

  • Demographically young (20-29 years of age)
  • Unencumbered by debt, but assets and credit-poor
  • Income is low, generating little surplus savings to invest, but
  • Generating economic growth and value added, as well as strong consumption in entertainment and non-durable consumables
  • Held back by ageing workforce at the top of career ladders and by lack of jobs in the 'normal' (ex-ICT and specialist skills) economy
  • Emigrating for better career opportunities: population of this cohort in Ireland has declined 112,200 since 2011.

Ireland of ‘left-outs’

  • Encumbered by legacy debt, 
  • Unemployed or in low jobs security and 
  • Hit by high taxes and cost of living
  • Hit by pensions insecurity and investments values collapse
  • Demographically in their prime productive age: 35-49 years
  • This cohort is growing over time even if immediate arrears on mortgages are declining

What do we see on the ground in this economy? 


  • GDP at constant factor cost is up 5.37% y/y in H 2014, but only 3.72% on H1 2011.
  • Due to a number of factors impacting changes in the ways that MNCs book profits into and out of Ireland, GNP rose 6% y/y in H1 2014 and is up 8.2% on H1 2011. Again, very strong.
  • Taxes in the economy are up 11.5% on H1 2011 and 8.1% on H1 2013. The Governments took EUR11.7 billion in income-related taxes increases since Budget 2009.
  • Much of recorded growth in 2014 is coming from the sources that have little tangible connection to reality: reclassifications of R&D activities, MNCs, etc.

Year on year, growth is concentrated in:

  • Agriculture (at 11.9% y/y or 2.2 times the rate of overall growth). Large part of this is down to price effects;
  • Distribution, Transport, Communications and Software (+10.9% y/y or double the rate of growth overall);
  • Building and Construction (+8.3% y/y growth or 1.5 times rate of overall expansion); much of this is down to timing of tax incentives, as well as changes in regulations;
  • Public Administration & Defense (+3.7% y/y) as we are witnessing massive shift toward charging for public services and paying interest on debt. In 2015, Interest on Government debt will amount to EUR8.5 billion, more than 1.8 times greater than the projected Corporation Tax take.
  • ‘Other Services, including Rent’ (+3.3% y/y)

Much weaker growth was recorded in

  • Industry overall (+0.6% y/y) and especially in Transportable Goods Industries and Utilities (+0.16% y/y)

In terms of demand side of the economy:

  • Fabled return of consumers is quite overhyped for now: Personal Consumption is up only 1.2% y/y in H1 2014 and is still down 2.7% on H1 2011. Value of core retail sales rose only 0.28% in 3mo through August 2014 compared to 3mo through May 2014. Volume rose 0.29%. This is hardly a ‘boom’.
  • Meanwhile, net current expenditure by the Government is up 5.2% y/y in H1 2014 and is basically flat (-0.2%) on H1 2011. Austerity on the spending side of Government has been a transfer of payments from services to national debt funding.
  • Gross Fixed Capital Formation is up massive 11.3% y/y in H1 2014 and is up 2.3% on H1 2011, but most of the uplift is down to resale of properties. This also includes buying activities by the vulture funds. 

External Trade is booming – despite tough external economic conditions:

  • Exports of goods were up 13.2% y/y in H1 2014 and are up 9.6% on H1 2011
  • Exports of services up 7.1% y/y in H1 2014 and 24.6% on H1 2011
  • Problem is: national accounts data is now in a total disconnect from the actual trade data. In the past, average discrepancy was around EUR1 billion per quarter. Now we are witnessing National Accounts exceeding trade data statistics by 7 billion. So quality of data is starting to look wobbly.
  • Strong support for our exports is provided by our traditional exposure to the US and UK markets. But we are also seeing encouragingly strong performance in some new markets, e.g. Russia and China, again against the general trend toward slower demand in these economies.

What we do know about the domestic economy is still quite troubling:

  1. Debt: 165,674 accounts in arrears in Q2 2014 – EUR33.6 billion in balances. Restructured: 125,763 accounts of which 48,862 are still in arrears. Total mortgages at risk of arrears or in default: 256,146 with balances of EUR46.06 billion. Over 50% of all ‘permanently restructured’ mortgages involve same or higher levels of life-cycle debt. 39% of all ‘permanently restructured’ mortgages are back in arrears, absent any significant shocks to interest rates, inflation or incomes.
  2. Income: In real (inflation-adjusted) terms, Irish GDP per capita in 2014 is expected to be 11.9% lower than pre-crisis peak. This is the third worst performance in the Euro Area (after Cyprus and Greece). Lack of income uplift means that households’ deposits are trending slightly down in recent months. Labour force participation rate fell in Q2 2014 and at 60% is below the historical average of 60.8%. Which suggests that a large part of declines in unemployment is accounted for by people simply dropping out of the labour force.
  3. Tax system: In 2006, Income tax and levies accounted for 27.2% of our total tax burden, while Corporation Tax accounted for 14.7%. This year, Income Tax + Levies will account for 41.9% and Corporation Tax for 11%. In 2015, based on Budget 2015 estimates, Income Tax burden of funding the state will be 42.5% and Corporation Tax burden will be 10.8%. In simple terms, at the peak of the 1980s crisis, Income Tax and Levies burden was 41.8% average for 1984-1989 period. Budget 2015-costed income tax and USC changes total EUR478 million in ‘stimulus’ to the economy. Yet, Budget 2015 for HSE includes EUR330 million of undefined “one-off revenue enhancements” (aka tax on services) and Irish Water is expected to extract EUR175-190 million out of economy net  of tax credits. Which implies that Budget 2015 will still draw money out households.
  4. Entrepreneurship and investment: There is no significant growth in entrepreneurship, despite the claims of rising number of companies registrations. In reality, companies registrations numbers tell us little about entrepreneurship as we do not know if these are new enterprises or old ones that were forced to shut down by the crisis re-registering once again. We do not know how many of the new companies are being registered by spinning off existent companies functions to avail of 3-year tax exemption. In a number of sectors, there are now multiple enterprises trading from the same business platform. What we do know, however, is that Budget 2015 contained virtually zero cost-linked measures for business development or entrepreneurship supports. 3 year relief for start-up companies is costed in the Budget at EUR2 million for the Full Year, which, applying 12.5% tax rate implies profit run rate of EUR16 million or revenues / turnover of around EUR64-80 million for start ups launched 2013-2015. This is ridiculously low for an allegedly thriving ‘Entrepreneurial Culture’. Meanwhile, on supports side, Budget 2015 contained 11 measures to support agriculture, with largest measures aimed at supporting incomes from leases on unproductive land ownership. Worse, the starting point for much of entrepreneurship is self-employment. Budget 2015 literally pushed higher earning self-employed (those with higher investments in human capital, skills, knowledge, etc) over the cliff with new USC changes. The Government policy is now to actively pursue, hunt down and kill off anyone who is standing on their own, takes risks and creates own value added.
  5. Innovation and R&D: Just three MNCs operating from Ireland account for 70% of all R&D activity here measured by patent filings: Accenture – 31%, Covidien – 24% and Seagate – 15%. In more recent data, foreign companies filings in Ireland have continued to outstrip Irish companies filings by a factor of 3:1. Ireland operates a large number of public intervention and support schemes to increase R&D and Innovation share of our economy. Yet there is not a single, coherent, comprehensive data reporting channel on what these schemes achieve on the ground. It appears that in this country, more knowledge and innovation is a pursuit best managed in the fog of obscured accountability.

On the net, the state of play in the Irish economy is that of a gentle uplift in the domestic economy with risks weighted to the downside.

  • This is a fragile (due to risks) recovery on the ground, despite the fact that aggregate numbers are trumpeting the rise of the Celtic Phoenix. For now, there’s a lot of smoke, some strong wings flapping, but not a hell of a lot of flying, yet.
  • Global risks are weighting growth prospects to the downside too, but Ireland is clearly benefiting from three idiosyncratic sources of strength:

    1. We are benefitting from stronger demand in the US and the UK; and
    2. Our indigenous exports, small as they might be, are performing well – a testament to longer-term relationships built by Irish exporters around the world.
    3. Finally, the sheer scale of collapse in the economy during the crisis means we should expect a more robust bounce up. 

We can expect:

  • Robust aggregate growth figures in 2014 (ca 4.1% on GDP side and 4.7% on GDP side or higher, depending on what and how is going to be booked into Ireland by the MNCs) and weaker, but still substantial growth of 3.0-3.6% on GNP side and 3.5-3.9% on GDP side in 2015.
  • Slower growth is expected to result in continued weakening in employment growth: in 2011 we posted 2.3% growth, in 2014 we are likely to post 1.8% growth and in 2015 – closer to 1.5-1.6%. The risk here is to the downside.
  • Consumption growth is probably going to be around 2-2.5% in 2015 after 1.5-1.7% rise in 2014.
  • Investment will slowdown from 2014 estimated growth of 14.5-15% to 10-12% in 2015. Again, risk here is to the downside, should Budget 2015 changes on property side induce early purchases rush in the remaining months of 2014. Big unknown for 2015 is the rate of foreclosures on arrears-ridden properties. This can derail the recovery altogether and significantly depress sentiment in the economy. 

All in, 2015 is expected to be another year of recovery, amidst risky trading environments.  And 2015 recovery is going to be a bit more balanced.

The key risks, however, are now being shifted to 2016 – the year of more aggressive tapering by the Fed and the expected start of the monetary tightening cycle in the euro area.  Before then, accommodative policies by the ECB will keep rolling in, although their effects on growth will be most felt probably in H1 2015.

Still, for now at least, the theme of ‘fighting for survival’ that characterised the Irish economy in 2008-2013 is over and we have some hopes that the new theme of ‘fighting for growth’ is commencing.

18/10/2014: Latest news on Russian economy

In the week this was, much of my attention was on Irish economy (given the Budget 2015 shower of news), so here's a quick catch up on Russian economy news.

Fresh off the printing press, Moody's downgraded Russia credit ratings from Baa1 to Baa2. Per Moody's moody grumblings: "The first driver for the downgrade ...relates to the longer term damage the already weak Russian economy is likely to incur as a result of the ongoing crisis in Ukraine and, relatedly, the additional sanctions imposed against Russia." More bad news: the agency is maintaining Russia's outlook at "negative".

Let's face the music: so far in October, Russian Central Bank spent some USD13.5 billion in a futile attempt to hold ruble from sliding against USD and the euro. This is not good news as it signals three things:

  1. Flood of capital out of Russia continues and seems to have resumed with renewed strength in last 30-45 days after a brief slowdown in May-August.
  2. The combined effects of (a) general outflow of funds from Emerging Markets, (b) falling exports revenues on foot of collapsing prices of oil, © building of arrears against some importers of Russian gas (actually that would be Ukraine alone), (d) general volatility in the global markets, and (e) rumours of capital controls and deteriorating business climate in Russia, including in the shadow of the Russian banks facing pressures from the EU and US funding markets shutdown and talks of SWIFT disconnection, all are now acting to reinforce the adverse effects of the geopolitical mess in the Ukraine. [Note: here's the latest on SWIFT saga:]
  3. There is now political economy kicking into high gear when it comes to ruble valuations: after  continued depreciation of the ruble against all major currencies stretching over some 12 months, we are starting to see some serious concerns in both the Central Bank and the Kremlin that more devaluations will be translating into serious pain on the ground for ordinary consumers.

Chart below (via Bofit) to illustrate the degree of interventions and associated exchange rates:

On the above point (2): Bofit reports that "Russian banks repatriated a record high amount of their assets from abroad in order to balance their forex positions as Russian firms and households reduced their domestic forex deposit accounts with Russian banks. ...Russia’s large state banks repatriated assets from abroad also in case there was an as-set freeze. Net borrowing of banks from abroad was strongly, and to an unusual degree, negative." In other words, banks were repaying foreign loans much more aggressively than rolling them over. Corporate capital outflows rose big time in Q3. This was driven by liabilities flows, which became negative in Q3 as companies aggressively paid down foreign debt and received virtually no new debt from abroad. It is worth noting that official capital outflows include not only funds expatriated abroad, but also private (corporate and household) funds converted into foreign currency, even if these funds never leave Russia.

And on the above point (2)(d), two weeks ago the rumours were so strong that the Central Bank of Russia had to issue a note denying the capital controls were under consideration.

The general sentiment in the EM asset markets is that of a heavy risk-reweighting in the mature economies pushing massive outflows of funds from the EMs. Risk-off sentiment is certainly on this week across global markets. Ongoing volatility is high and rising and signals general nervousness in the global markets. This is fuelling a strong sell-off in risky assets, especially in the EMs. Addicted to endless increases in liquidity supply, the markets are clearly waiting for the Central Banks to open the taps once again. Absent such action, there is no fundamental reason for current asset valuations in any region in the world.

Ruble is getting hammered, with the largest catalyst for change being oil prices. Currently RUB/EUR is at 52.3 and RUB/USD is at 40.8. Two weeks ago, we had RUB/EUR at 50.5 and RUB/USD at 39.6. Month ago: RUB/EUR at 48.4 and RUB/USD at 36.8. Ugly!

In the short run, I can see both rates rise by around 5 percent (3mo outlook) and at 12 months horizon, my expectation would be for RUB/EUR is at 54.0-55.0 and RUB/USD is at 43.0-44.2.

With ruble plunging, imports are also falling off the cliff. Latest data from the Central Bank show Q3 2014 current account surplus hitting another 2 year high. Over 12 months through September 2014, Russian current account surplus averaged almost 3% of GDP. Goods trade surplus has been running at nearly 10% of GDP. This is despite a small decline in exports of goods and services in Q1 and Q3 2014 and virtually zero growth in exports in over 2 years. In contrast, imports fell 6-7% y/y in the first 9 months of 2014 and in Q3 2014. Goods imports declined 8%. Chart below (courtesy of Bofit) illustrates:

On the net, current account position is still strong, but trending around post-crisis levels. Lower oil prices should significantly harm this, especially as supports from imports declines start to wear out over time.

Thursday, October 16, 2014

16/10/2014: Euro Area Industrial Production Losing Momentum... What Momentum?..

A nice chart from Pictet, graphing industrial production in the US against the Euro area:

Everyone is talking about 'fading momentum' in euro area industrial production... my view: what 'fading momentum'? Euro area industrial output has been on a declining trend for more than 36 months now. The 'recovery' from Q1 2013 through Q1 2014 was a blip - so weak in any 'momentum' it is not worth mentioning.

The chart basically shows no gains on output in the sector for the euro area since 2000-2003 averages. If there was any 'momentum' in the series before the last couple of months, would anyone please point it out?

16/10/2014: Ireland's Real Recovery Metrics: Try Avoiding that Over-Confidence Trap

So 7 years into the crisis, and Ireland is 'securing' the 'robust recovery' according to the Government. Securing? Well, here's the chart based on IMF latest projections for real GDP growth in 2014 (never mind, GDP is not that great metric for Ireland, but that's all we have to compare across the economies as of now).  The data is on per-capita basis and the index reflects 100=value of real GDP per capita in the year of pre-crisis peak.

So how is Ireland faring?

Ah, as of 2014, with 'robust recovery' being 'secured' we are the third worst-off economy in the Euro area, with GDP per capita in real terms down 11.9 percent on pre-crisis peak and 7 years (longer-tail of the range) duration of the crisis. Two economies worse off than our 'robustly recovering' one are: Greece and Cyprus. And of these, only Greece is as long into the crisis as Ireland.

But, I hear you say, things are improving in Ireland faster than anywhere else... Shall we take a look?

The rate of improvement is measured by the slope of the line. By this measure, Ireland in 2014 is indeed improving faster than anyone else, except the recovery is close to or on par with Latvia, Slovakia and Malta. But here's a kicker: 2014 rate of improvement in Ireland is similar to the rates of improvement attained in the past during this crisis by:

  • Latvia in 2011, 2012, 2013 and 2014
  • Finland in 2009 and 2010
  • Malta in 2010, 2013 and 2014
  • Slovakia in 2009, 2010 and 2014
  • Germany in 2010 and 2011
  • Austria in 2011
So our 'unique today' is not as unique as we would like it to be, both today and historically over the crisis period.

Time to be a bit more humble, perhaps? Just to avoid falling into over-confidence fallacy?

16/10/2014: Stating the Obvious, yet the Un-mentionable

With all the talk about 'inflation is too low' in Europe, let me put it to you succinctly: It is not the inflation, stupid! It is income, aka consumers capacity to sustain demand...

In real terms, and with illicit drugs and prostitution factored in, whilst counting in addition bogus R&D reclassifications and other 'bells and whistles' of national accounts, only TWO of the Euro Area 12 'rich' economies have managed to regain their pre-crisis real GDP per capita peak: Germany and Austria. One of them - Germany - has no demographic driver for increased demand. So go figure: price inflation is low because incomes are low! Not because monetary authorities are not doing something. Nor because Germany is dragging Europe down. May be, because, in part, fiscal authorities have taxed the daylights out of people. And may be because banks have shoved so much credit into households prior to the crisis than few can borrow much more to sustain unsustainable (judging by income growth) consumption growth.

So again: It is not the inflation that is too low, stupid! It is income, aka consumers capacity to sustain demand, that is too low...

Wednesday, October 15, 2014

15/10/2014: Changing Nature of Financial Diversification

My new blog post on Learn Signal Blog covering the changing nature of diversification in financial markets:

Certainly of use to our MSc in Finance class!

Tuesday, October 14, 2014

14/10/2014: Budget 2015: Of Double Irish and Tax Non-Reforms

This Budget was supposed to be about giving working families something back. In the end, it was not.

The core asymmetry in Irish tax system has been, since the onset of the crisis, increasing burden of State on ordinary incomes. This remains.

2014 projected income tax take is EUR17.18 billion out of total tax take of EUR41.04 billion. 2015 projected income tax at EUR17.98 billion against total tax take of EUR42.3 billion.

Corporation tax: 2014 projection for EUR4.525 billion and 2015 at EUR4.575 billion.

So as a share of total tax take, income tax continues to rise, corporation tax continues to fall.

There is no re-balancing of tax system. Households pay. Full stop.

Of core measures, announced, corporate tax reforms are the biggest. As predicted, 12.5% headline rate is here to stay. Minister Noonan sounded like a politician cornered by someone with a bit more power (Germany? US? EU? UK? all of the above?) on the topic. And he stayed his ground (absent visible opponents).

But the 'non-tax-haven' tax loophole of the Double Irish was abolished, as predicted. For new companies coming into Ireland - starting with 2015 - all companies resident here will be resident here for tax purposes too. For existent companies, the new provision comes into force at the end of 2020. Transition period will see more tax optimised activity being booked through Ireland as corporates embark on building up cash reserves. This firmly puts any risk of economic activity falloff after the full abolition of the Double Irish out into next Government, so should FF or SF or both win next elections, they will bear the weight of any disruptions. Before then, however, more will flow through Ireland on the way to real tax havens.

It is worth reminding that in October 2012, Minister Noonan steadfastly claimed that abolishing Double Irish provision was not within his remit.

Minister Noonan also set out some sketch of the forthcoming tax reforms. These will:

1) Remove completely any base year consideration in application of R&D tax credits. The measure will take hold from January 1, 2015 and will create more incentives to book R&D spending into Ireland. Whether this will tangibly increase actual R&D activity here remains to be seen, since R&D investment is even harder to price than transfer pricing in the services sector. Suppose a lab located in, say, New Hampshire develops a formula for new drug. But final preparation is registered into Ireland. All R&D investment, save minor expenditure on lab operations, can be billed into Ireland, in exchange for having a 'token' small lab of formula preparation team here. make a key scientist fly into Dublin for a couple of meetings and you have magic R&D activity here that can easily exceed activity in the actual lab. The “knowledge box” will, presumably, tax corporate profits generated as a result of patented innovations in a way similar to so-called 'patent box' structures already in place in the Netherlands and the UK. UK 'box' has a tax of 10% , Netherlands' one has 5%, and Minister Noonan promised Irish equivalent will be 'the best in class', so it will need to undercut the already existent ones. Which means that the above-mentioned example of an 'investment' will book profits into Ireland as payments on R&D-generated IP and these will be taxed at a reduced rate.

2) Aim to deliver even more 'competitive' environment for 'intangible assets' domiciling in Ireland. In other words, the fabled IP pushed through the fabled 'Knowledge Development Box', aka black box tax system that leaves IP outside tax net. This should sweeten the removal of the Double Irish for MNCs, especially in the IP-intensive ICT services sector. But it will also mean preciously little in terms of incentivising real activity on the ground here. Instead of shifting profits to Bahamas to get them off the tax hook, MNCs can just book payments into Ireland as payments on IP, making them basically tax free too.

3) To facilitate internationally trading sector, Budget 2015 enhances Special Assignee Relief Programme

4) To address future criticisms of the new system as being unfair to our trading partners, the Revenue will get additional resources to act as a 'competent authority' in enforcement and monitoring of corporation tax matters.

Gas bit is: the EU Commission is already investigating if 'patent-knowledge' box schemes constitute illegal state aid.

One simply cannot assess the full impact of the new changes on the economy. We have no data on specific activities by MNCs here. We have no data on operating tax structures. We have no data on how MNCs can re-arrange their activities here to address the challenge. It is, however, safe to assume that none of existent MNCs will be rushing to do much before 2020. And it is also safe to assume that by 2020, when the Double Irish fully bites the dust, the OECD-led BEPS reforms will be already known.

This, in effect, will mean that Ireland's Double Irish abolition today is a preemptive move that preempts nothing but bad PR. Reputational gain. Opportunity of real reforms for now remains a distant hope.

14/10/2014: Budget 2015: Economic Forecasts a Bit Optimistic

Here's my take on economic side of the Budget 2015 projections:

Gross current expenditure for 2015 will be just over €50 billion. This figure represents an increase of €429 million over the 2014 Revised Estimates. Note: in H1 2014, Government spent EUR35.567 billion which is EUR1.255 billion more than in the same period 2013. As unemployment fell, social benefits rose from EUR13.823 billion to EUR14.016 billion. General Government Deficit has fallen only EUR307 million y/y in H1 2014. These numbers are not consistent with strong economy or strong fiscal performance. Meanwhile, the state took out of the economy EUR1.893 billion more in taxes and social contributions in H1 2014 compared to H1 2013. Where did this increase of funding go?

Government deficit target for 2015 is 2.7% of GDP under ESA 2010 classification. Which means that going back to Troika programmes-comparable measure (ESA 1995 classification), the target deficit is closer to 3.2% of GDP. This is ahead of 3% target and shows how much debt we owe not to smart management of resources, but to accounting rules changes.

Here's a set of economic puzzles courtesy of the Department of Finance:

Real growth is slowing down from 2014 levels, but employment generation is rising. A puzzle. Especially as domestic demand is expected to grow at same rate in 2015 and growth rate is expected to fall in years after.

As compared against other organisations forecasts:

Added puzzle: IMF projections for Irish economy real GDP growth are: 2015 3.045% - full 0.85 percentage points lower than DofF, 2016: 2.538% which is full 0.87 percentage points below DofF, in 2017 : 2.649% or 0.75 percentage points below DofF… and so on.

And another kicker in the teeth… the promise of fiscal rectitude and 'no going back to boom-and-bust cycles':

All of the above is rather academic, since the Department of Finance refuses to forecast Gross Voted Current expenditure of the Exchequer beyond 2015, setting all of it at EUR50.075 billion for each year 2015-2018. Which means the estimated effects on deficit and on borrowing are based on assuming zero growth in spending and continued growth in tax revenues. Happy times roll, even though Haddington Road agreement is about to expire.

Still, as you can see, debt/GDP ratio is expected to fall, courtesy of higher GDP, including the new classification effects that came into force this year. But debt itself is not expected to fall. Instead, from EUR 203.2 billion, Government debt is expected to rise to EUR 215 billion in 2017 and basically stay there in 2018.

So on the balance: a bit too much optimism, especially past 2015. Not enough risk cushion. May the numbers turn out this well in reality...