Thursday, January 29, 2015

29/1/15: Where the Models Are Wanting: Banking Sector & Modern Investment Theory

My new post for Learn Signal blog covering the shortcomings of some core equity valuation models when it comes to banking sector stocks analysis is now available here:

Tune in next week to read the second part, covering networks impact on core valuation models validity.

Tuesday, January 27, 2015

27/1/15: Greek Debt: Non-Crisis Porkies Flying Around

There is an interesting sense of dramatic contradictions emerging when one considers on the one hand the outcome of the Greek elections, and on the other hand the statements from some EU finance ministers (for example see this: The basic contradiction is that one set of agents - the new Greek government and the Greek electorate - seem to be insisting on the urgency of a debt writedowns, while the other set of agents - majority of the European finance heads - seem to be insisting on the non-urgency of even discussing such.

What's going on?

Here is a neat summary of official (Government) debt redemptions coming up, by the holder of debt (source: @Schuldensuehner):

This clearly, as in daylight clear, shows 2015 as being a massive peak year for redemptions.

Note to the above: GLF debt reference covers GDP-linked bonds - see

Alternative way of looking at the burden of debt is to compare debt dynamics and debt funding costs dynamics. Here these are for Greece, based on IMF data:

Take a look at the above blue line: in effect, this measures the cost of carrying Government debt. This cost did improve, significantly in 2012 and 2013, but has been once again rising in 2014. It is projected to continue to rise into 2019. So Greece can run all the primary surpluses the Troika can demand, the cost of servicing legacy debts is on the upward trend once again and Herr. Schaueble and his ilk are talking tripe.

Now, consider the red line in the chart above: in absolute terms, there is no reduction in Greek debt to-date compared to 2012. But do note the third argument advanced by Herr. Schaueble in the link above, the one that states that Greek debt reductions have exceeded those forecast under the programme. Did they? Chart below shows the reality to be quite different from that claim:

What the chart above shows is that 2015 projections for debt/GDP ratio (the latest being published in october 2014) range quite a bit across different years when forecast was made. Back in October 2010, the IMF predicted 2015 level of debt/GDP ratio to be 133.9%, this rocketed to 165.1% in October 2011 forecast, rose again to 174.0% forecast published in October 2012, declined to 168.6% in forecast published in October 2013 and rose once again in forecast published in October last year to 171% of GDP.  In other words, debt outlook for Greece for 2015 did not improve relative to 3 forecast years and improved only relative to one forecast year. Rather similar case applies to 016 projections and 2017 projections and 2018 projections. So where is that dramatic improvement in debt profile? Ah, nowhere to be seen.

And then again we keep hearing about the fabled end of contagion, 'thank God', that Herr. Schaeuble likes referencing. I wrote about this before, especially about the fact that risk liabilities have not gone away, but were shifted over the years from the shoulders of German banks to the shoulders of German taxpayers. But you don't have to take my word on this, here's a German view:

27/1/15: Bankruptcy & Capitalism Are Not the Same as Religion & Hell

I have recently seen some economists offer the following explanation of the role of bankruptcy in the market economy: "Capitalism without bankruptcy is like catholicism without a concept of hell".

That is a fallacious view at best, and a dangerous basis for policy formation to boot.

It is fallacious for a number of reasons, relating to both philosophy and economics.

Firstly: Capitalism, unlike religion is an ethical, but not a moralist (imperative) system. Hence, a concept of eternal damnation simply does not apply, nor should apply, to capitalism. Nothing eternal (imperative) is relevant to capitalism, including the principle of permanently enshrined law. In fact, capitalism is a system that is based on change, including change applying to its core principles. Example: transition in property rights definition as it evolved under capitalism. Change is something that is impossible in a moral imperative systems: the Hell is the Hell and it will always be the Hell. In contrast, even the most basic foundations of capitalism evolve over time. Humanity used to have markets for slaves. We no longer do, for a good of the system. Capitalism used to define capital as physical 'stuff', it now includes 'intangibles'. And so on. This ability of capitalism to change - both continuously (evolutionary) and discontinuously (revolutionary) - preempts any possibility of an 'eternal' value concept, such as 'Hell', applying to it.

Secondly: Capitalism is based on utilitarian ethics. It is ok to alter private property rights (even with partial only compensation) under certain circumstances. It is ok to restrict some markets and transactions, when Pareto efficiency allows us. And so on... There can be no Pareto efficiency justification for a fundamental sin. Hence, bankruptcy in capitalism is not a form of punishment (damnation) a priori, but a system for resolving dilemma of un-recoverable liabilities. It is instrumental - a resolution system and a restart system. Hell is a permanent state, inescapable once entered into. And Hell exists solely for the purpose of punishment. It is not instrumental - it is absolute.

Thirdly: Bankruptcy is a manifestation of the process of creative destruction. Which is a dynamic process and also value-additive process. Hell is a system of a final state of being. There is neither a desirability for finality, nor transformative imperative to alter a being through bankruptcy.

In short, a statement of "Bankruptcy ~ Hell", while sounding remotely plausible, commits a basic fallacy of moralism: over-extending an imperative moral consideration to something that requires none.

So why do I take this statement to task?

Precisely because our system of bankruptcy is erroneously designed to follow that fallacious principle. We use bankruptcy not to resolve the problem of un-repayable liabilities in the first action, but to punish the person / entity that caused the problem. We make bankruptcy painful beyond the reason of simply maximising the recovery of losses in order to 'teach others a lesson' in a way that the threat of Hell is supposed to do.

As long as we keep following such a moralist view of bankruptcy, we will continue to unncessarily penalise entrepreneurship and risk-taking; we will continue to force unnecessarily high costs of failure on enterprises and people that undertake enterprise. In other words, we will continue to subsidise returns and rewards to statism to a life of secured complacency.

Capitalism without bankruptcy is a prison without an exit. It imprisons, wrongly, the innocents to rescue bankrupt enterprises (as in the case of banks rescues), or it imprisons too harshly those who take a risk and experience a failure (as in the case of some entrepreneurs trapped in, say, Nama). In both cases, absence of a utilitarian (not absolutist or moralist) bankruptcy destroys value - economic, social and personal.

Hell is the concept of an ultimate judgement and eternal punishment for moral sins, best left to God to apply, than economists.

Monday, January 26, 2015

26/1/15: Markets v Greece: Too Cool for School... for now

There is much talk about the impact (or rather lack thereof) of Greek elections on the markets.

In fact, the euro continued to price in the effects of a much larger factor - the QE announcement by the ECB, the stock markets did the same. Only bonds and CDS markets reacted to the Greek elections, and even here the re-pricing of Greek risks was moderate so far (see chart below and the day summary for CDS - both courtesy of CMA).

The reason for this reaction is two-fold.

Firstly, Greece is a small blip on the overall radar map of Euro area's problems. Even in terms of Government debt. Here is the summary of the Government debt overhang levels (over and above 60% of debt/GDP benchmark) across the Euro area:

In simple terms, real problems for the euro, in terms of risk pricing, are in Italy, France and Spain.

Secondly, Greece is a political risk, not a financial risk to the Euro area. And it is a risk in so far, only, as yesterday's election increases the probability of a Grexit. But increasing probability of a Grexit does not mean that this increase is worth re-pricing. It is only worth worrying about if (1) increase in probability is significant enough, and (2) if elections changed the timing of the possible event, bringing it closer to today compared to previous markets expectations.

Now, here is the problem: neither (1) nor (2) have been materially changed by the Syriza victory last night. My comments to two publications yesterday and today, summarised below, explain.

Greek elections came as a watershed for both the markets analysts and the European elites, both of which expected a much weaker majority for the Syriza-led so-called 'extreme left' coalition. The final outcome of yesterday's vote, however, is far from certain, and this has been now fully realised by the markets participants.

The confrontation with the EU, ECB and the IMF, promised by Zyriza, is but one part of the dimension of the policy course that Greece will take from here on. Another part, less talked about today in the wake of the vote is accommodation.

Let me explain first why accommodation is a necessary condition for both sides in the conflict to proceed.

Greece is systemically important to the euro area, despite all claims by various European politicians to the contrary. Greece is carrying a huge burden of debt, accumulated, in part due to its own profligacy, in part due to the botched crisis resolution measures developed and deployed by the EU. It's debt is no longer held by the German, French and Italian banks, so much is true. German and French banks held some EUR27 billion worth of Greek Government debt at the end of 2010. This has now been reduced to less than EUR100 million. There is no direct contagion route from Greek official default to the euro area banking sector worth talking about. But Greek private sector debts still amount to roughly EUR10 billion in German and French banking systems (with more than EUR8 billion of this in German banks alone). Greek default will trigger defaults on these debts too, blowing pretty sizeable hole in the euro area banks.

However, lion's share of Greek public debt is now held in various European institutions. As the result, German taxpayers are on the hook for countless tens of billions in Greek liabilities via the likes of the EFSF and Eurosystem.

And then there is the reputational costs: letting Greece slip out into a default and out of the euro area will mark the beginning of an end for the euro, especially if, post-Grexit, Greece proves to be a success.

In short, one side of the equation - the Troika - has all the incentives to deal with Syriza.

One the other side, we can expect the fighting rhetoric of Syriza to be moderated as well. The reason for this is also simple: the EU-IMF-ECB Troika contains the Lender of Desperate Resort (the ECB) and the Lender of Last Resort (the IMF). Beyond these two, there is no funding available to Greece and Syriza elections promises make it painfully clear that it cannot entertain the possibility of a sharp exit from the euro, because such an exit would require the Government to run a full-blown budgetary surplus, not just a primary surplus. For anyone offering an end to austerity, this is a no-go territory.

So we can expect Syriza to present, in its first round of talks with the Troika, some proposals on dealing with the Greek debt overhang (currently this stands at around EUR 210 billion in excess debt over the 60% debt/GDP limit), backed by a list of reforms that the Syriza government can put forward in return for EU concessions on debt.

These reforms are the critical point to any future negotiations with the EU and the IMF. If Syriza can offer the EU deep institutional reforms, especially in the areas so far failed by the previous Government: improving the efficiency and accountability of the Greek public services, robust weeding out of political and financial corruption, and developing a functional system of tax collections, we are likely to see EU counter-offers on debt, including debt restructuring.

So far, Syriza has promised to respect the IMF loans and conditions. But its rhetoric about the end of Troika surveillance is not helping this cause of keeping the IMF calm - IMF too, like the ECB and the EU Commission, requires monitoring and surveillance of its programme countries. Syriza also promised to balance the budget, while simultaneously alleviating the negative effects of austerity. In simple, brutally financial terms, these sets of objectives are mutually exclusive.

With contradictory objectives in place, perhaps the only certainty coming on foot of the latest Greek elections is that political risks in Greece and the euro area have amplified once again and are unlikely to abate any time soon. Expect the Greek Crisis 4.0 to be rolling in any time in the next 6 months.

So in the nutshell, don't expect much of fireworks now - we all know two deadlines faced by Greece over the next month:

These are the markers for the markets to worry about and these are the timings that will start revealing to us more information about Syriza policy stance too. Until then, ride the wave of QE and sip that kool-aid lads... too cool to worry about that history lesson, for now...

26/1/15: If not Liquidity, then Debt: ECB's QE competitive limping

I have written before, in the context of QE announcement by the ECB last week (see here: that the real problem with the euro area monetary and economic aggregates has nothing to do with liquidity supply (the favourite excuse for doing all sorts of things that the ECB keeps throwing around), but rather with the debt overhang.

In plain, simple terms, there is too much debt on the books. Too much Government debt, too much private debt. The ECB cannot even begin directly addressing the unspoken crisis of the private debt. But it is certainly trying to 'extend-and-pretend' public and private debt away. This is what the fabled EUR1.14 trillion (or so) QE announcement is about: take debt surplus off the markets so more debt can be issued. More debt to add to already too much debt, therefore, is the only solution the ECB can devise.

While EUR1.14 trillion might sound impressive, in reality, once we abstract away from the fake problem of liquidity, is nothing to brag about. Take a look at the following chart:

Forget the question in red, for the moment, and take in the numbers. Remember that 60% debt/GDP ratio is the long-term 'sustainability' target set by the Fiscal Compact - in other words, the long-term debt overhang, in EU-own terminology, is the bit of debt above that bound. By latest IMF stats, there is, roughly EUR3.5 trillion of debt overhang across the euro area 18, just for Government debt alone. You can safely raise that figure by a factor of 3 to take into the account private sector debts.

Which puts the ECB QE into perspective: at the very best, when fully deployed, it will cover just 1/3rd of the public debt overhang alone (actually it won't do anything of the sorts, as it includes private and public debt purchases). Across the entire euro area economy (public and private debt combined) we are talking about the 'big bazooka' that aims to repackage and extend-and-pretend about 10-11% of the total debt overhang. Not write this off, not cancel, not burn... but shove into different holding cell and pretend it's gone, eased, resolved.

This realisation should thus bring us around to that red triangle and the existential question: What for? Between end of 2007 and start of 2015, the euro area has managed to hike its debt pile by some EUR3 trillion, after we control for GDP effects. Given that this debt expansion did not produce any real growth anywhere, one might ask a simple question: why would ECB QE produce the effect that is any different?

The answer, on a post card, to the EU Commission, please.

Sunday, January 25, 2015

25/1/15: Russian Current Account Improved in 2014

I have remarked on a number of occasions just how rapidly Russian current account can adjust to an external shock. This time around, the adjustment is via decreasing imports to compensate for both - the ruble devaluation effects and the sanctions/counter-sanctions effects, as well as the traditional economic recession pressures.

Based on the preliminary data from the Central Bank of Russia, Russian exports of goods and services fell 19% in dollar terms in Q4 2014 and were down 12% in euros. Russian imports of goods and services fell at the same rate.

Full year 2014 preliminary estimates show exports down 6% and imports down 9% in both dollar and euro terms. In 2013, exports of goods and services run USD593 billion or 28.3% of GDP. In 2014 exports of goods and services slipped to USD560 billion, but stood at 29.4% of GDP (these are dollar-denominated GDP figures). Trade balance in goods stood at USD182 billion (8.7% of GDP) in 2013 and this rose to USD186 billion (9.7% of GDP) in 2014. Trade balance in services also improved, from a deficit of USD55 billion in 2013 (-2.8% of GDP) to a deficit of USD55 billion (-2.9% of GDP) in 2014.

While goods imports contracted 10% over full year 2014, in Q4 2014, goods exports fell a whooping 19% in USD terms. Q4 2014 imports of tourism services (travel by Russian residents abroad) fell 20% compered to Q4 2013.

On the Financial Account side, State accounts excluding the Central Bank were in a healthy surplus of USD30 billion for the full year 2014, up on USD 5 billion in 2013.

Private sector accounts, however, were abysmal. Total Private Sector financial accounts finished 2014 with a deficit of USD150 billion (-7.9% of GDP) which is far worse than USD62 billion (-3.0% of GDP) in 2013. The USD150 billion figures is what we usually attribute to capital flight from Russia. This figure consisted of USD50 billion of financial deficit in the banking sector (against USD7 billion deficit in 2013) and USD 100 billion deficit on ex-banks private sector accounts (against USD55 billion in 2013).

Good news is: fictitious transactions (basically a shell-game with company money involving foreign offshore holding firms) shrunk dramatically in 2014: falling from the net outflow of capital via such transactions of USD27 billion in 2013 to net outflow USD 9 billion in 2014.

Another interesting note: as noted by me on numerous occasions, part of capital outflows was down to aggressive dollarisation of the economy at the end of 2014, which saw build up of private sector forex cash deposits held in Russia. Based on CBR data, in 2013 such deposits shrunk by USD0.3 billion, while in 2014 they rose by USD34 billion (USD18 billion of that increase took place in Q4 2014 alone).

Overall, Russian current account surplus improved significantly in 2014 despite all the cash outflows and decline in exports. In 2013, Russian current account surplus stood at USD34 billion (1.6% of GDP), and in 2014 this increased to USD57 billion (3.0% of GDP), with USD11 billion of that accruing in Q4 2014 alone.

We can expect more dramatic declines in both, oil and gas revenues on exports side and imports of goods and services in 2015. One key parameter to look at is exports and imports of services. The reasons for this are simple, albeit not easy to gauge or forecast.

Firstly, significant share of Russian exports of services (and also some associated imports) is down to effectively Russian companies producing services using (in accounting and also contracting sense) off-shore affiliates. We might see some of this activity being on-shored in Russia, with resulting decrease in imports and a rise in exports.

Secondly, Russian enterprises and investors are likely to cut back on imports of key financial, ICT and business consultancy services as the Russian economy suffers from downward pressures on investment and growth.

25/1/15: Swiss Out, Danes In: Pegs and Euro Mess

My comment from earlier this week on SNB and Denmark's Nationalbank pegs decisions (Expresso, January 24, 2015 page 09):

There are two truths about currency pegs.

The first one is that no Central Bank is an island. In other words, all pegs are temporary in their duration and costly in their nature, while held.

The second one is that exiting a peg with underlying conditions similar to those when the peg was set in the first place can never be a smooth and risk-free decision. Disruptive nature of such an exit is only highlighted by the necessity of the peg in the first place.

Swiss CHF to Euro peg is emblematic of the above two facts. The peg, de facto maintained from the summer 2011 (but officially launched on September 6, 2011) at the height of the euro area crisis, was designed to remove pressures on the Swiss Franc arising from the rapid acceleration of capital inflows from the euro area to Switzerland. The resulting inflows pushed values of CHF well beyond the sustainable bounds, threatening to derail the Swiss economy, heavily dependent (especially in 2011) on exports.

The cost of the SNB peg to the Swiss economy was manageable, but accelerating in recent months. As part of the peg, SNB printed CHF to purchase surplus euros. Bought euros were accumulated on the SNB balance sheet. recent devaluation of the euro against the US dollar, and expected future devalutations of the euro (on foot of upcoming ECB QE measures) pushes down the real value of these forex reserves accumulated by the SNB. Exiting the peg simply realigned these values to actual currency fundamentals and crystallised the loss in one go, de facto partially sterilising the inflows.

Chart below illustrates accumulation of Forex reserves by SNB from the peg introduction on September 6, 2011.

The disruption caused by the SNB exiting the peg has been significant. Some 46 percent of all Polish mortgages have been issued in CHF. Hundreds of thousands of loans in other Eastern European countries were tied to CHF as well. The cost of funding these loans rose by between 15 and 20 percent overnight, causing some panicked reactions from some Eastern European Central Banks. Beyond this, home-felt impact of SNB move has been less pronounced in the short run. However. in the longer term, stronger Swiss Franc is going to put severe pressure on Swiss exports and will likely result in deterioration in the overall balance of payments. Swiss economy is still heavily reliant on Forex valuations to support its global trade. Current world trade conditions - with the likes of Baltic Dry Index at 753,000 close to crisis period lows, and IMF projections for ever lower rates of global trade growth in 2015-2016 - all signalling serious pressures on Swiss exporters.

Denmark's decision to introduce a Krone/Euro peg this week is likely to fare about as well as that of the Swiss decision in 2011. Just as the Swiss, Danish regulators also set negative deposit rates to further reduce pressure on Krone from Euro inflows. However, the pressure on the Krone is rising not due to the crisis-related capital flight (as was the case with Switzerland in 2011-2013), but due to currency hedging in anticipation of the ECB quantitative easing move expected to be announced this week.

Danish peg is critically different from the SNB previous attempt to peg CHF. The reason for this is that Krone has a long-term link to the Euro and in effect current peg is simply a form of repricing this link. And, unlike CHF (which accounts for roughly 5.2 percent of global currency trading volumes), Krone is a relative minnow in the forex markets (its share of the global currency trade is only 0.8 percent).

The two factors make Krone peg more credible and less costly to defend over the medium term. But none of these factors help to alleviate the problem of currency valuations for Danish exporters, who will see their markets for exports more contested now that the Krone is appreciating against the Euro.

The reserves dynamics preceding the Denmark's peg introduction and the SNB peg announcement in September 2011 are similar: both currencies have sustained heavy 'buy' pressures and both pressures were driven by the crises in the euro area. SNB introduced the peg at relatively benign levels of forex reserves accumulation back in 2011 which, at the time, were nonetheless consistent with crisis-period peak levels. Denmark's Nationalbank's peg introduction also takes place close to crisis period peak of reserves accumulation and the question to be asked is: how much pain on DKK can Denmark take in this environment. 

Saturday, January 24, 2015

24/1/2015: CB of Russia Recent Interventions

In 2014, Central Bank of Russia spent USD83 billion on currency interventions, against total draw down of USD124 billion in foreign reserves held. At the end of 2014, CBR’s foreign currency reserves, including gold, were USD386 billion, down from USD510 billion at the beginning of 2014. As of December figures, Russian foreign exchange reserves rank 6th largest in the world, providing a cover for more than 15 months of imports at current running rate.

In first half of January, CBR spend some USD2.2 billion on currency markets interventions, issued foreign exchange repos for the amount of USD8.3 billion, with most of this (USD5.4 billion) in 28- and 365-day maturities.

24/1/2015: ECB v Fed: Why Frankfurt's QE is a Damp Squib

A neat chart from Pictet showing balancesheet comparatives for ECB and the Fed.

Setting timing issues aside (which are non-trivial), the quantum of ECB balancesheet expansion planned is still too weak and it is too weak relative to previous peak. The Fed balancesheet expansion followed three stages:

  • Stage 1 in 2008-2009 was sharp and more significant than for ECB.
  • Stage 2 covered Q1 2009-Q2 2011
  • Stage 3 covered Q1 2013 through Q3 2014.
  • There were no major policy reversals, only moderation, over the entire QE period.
In contrast, ECB balancesheet expansions were weaker throughout the period, and were subject to a major reversal in Q1 2013 - Q3 2014 period.

In effect, even with this week's boisterous announcement, the ECB remains a major laggard in therms of monetary policy activism, compared to all other major Central Banks that faced comparable risks.

Now, to timing. ECB is a de facto your family doctor who routinely forgets to apply medicine in time and under-medicates the patient after the fact. Frankfurt slept through the Q1 2009-H1 2011 and went into a delirious denial stage in Q1 2013-H1 2014. The inaction during two key periods meant that nascent recovery of 2010 was killed off and 2013-2014 can be written off as lost years. The lags in policy reaction by the ECB are monumental: as the Fed ramped up monetary expansion in Q4 2012, the ECB will be presiding over a de facto monetary (balancesheet) stagnation, if not contraction, until March 2015. Which means that during the critical years of deleveraging - of banks and the real economy - debt reductions in the European economy were neither supported by the institutions (bankruptcy and insolvency resolution regimes), nor facilitated by the monetary policy. Instead, monetary policy simple delayed deleveraging by lowering the interest rates, without providing funding necessary for the writedowns. This is diametrically different to the US, where deleveraging was supported by both monetary policy and institutional set ups.

Meanwhile, Germans are now at loggerheads with the rest of Europe, whinging about the 'abandoned prudence' of the ECB. Best summary of why they are dead wrong is here:

The circus of the euro area pretence at economic (and other) policymaking rolls on. Next stop, as always, Greece...

Friday, January 23, 2015

23/1/2015: Davos 2*&%: I am not a fan... Why?

Narcissistic, self-obsessed, publicity equivalent of the Maybach Exelero and about as useful for its stated purposes too, Davos World Economic Forum is an media fest ritual that probably costs the world more trees (chopped for all the glossy publications it generates) than anything else on the global events calendar every year.

Corporates and their media love it. Journalists are awe struck by its trappings - from hotel rooms prices, to cost of basic meals, to who they bump into in the corridors. Big wigs of global business have to have it, because, apparently, they have trouble (with all their private jets and first class travel seats) meeting each other in real life in New York or London or Singapore, where they live. A handful of select, usually consensus-circling economists and pundits provide a backdrop of 'intellectualism' to the gathering. You can't tell sell-side from buy-side because it is all sell-side - sell your own image.

Yes, I am not a fan. And to explain why, let me give you this link via @CapX by @DanHannanMEP which explains the entire Davos event in its headline:

H/T to @msgbi for highlighting the article.

23/1/2015: Russian Economy Growth Downgrades

On top of downgrades by the rating agencies, Russia also got downgraded by the host of international agencies - in terms of country growth prospects for 2015-2016. The IMF downgrade took 2015-2016 forecast for growth of 0.5% and 1.5% for 2015 and 2016 respectively published in October 2014 down to a contraction of -3.0% in 2015 and -1.0% in 2016. The Fund estimates 2014 GDP growth of 0.6% for the full year and Q4 2014 growth of zero percent compared to Q4 2013. Not bad for the economy going though a massive, multi-dimensional crisis. But a poor outlook for 2015-2016. IMF estimates are based on assumed oil price (full-year average weighted of 3 spot prices) at below USD60 but above USD55 (see, so closer to USD57.

The World Bank outlook, released on January 14th is a bit less gloomy when it comes to 2016. Per World Bank, "sustained low oil prices will weaken activity in exporting countries. For example, the Russian economy is projected to contract by 2.9 percent in 2015, getting barely back into positive territory in 2016 with growth expected at 0.1 percent." World Bank oil price assumption is USD66 per bbl.

EBRD notes that "Geopolitical risks from the Ukraine/Russia crisis remain significant, although they are contained for the time being." According to the bank, "Russia is projected to slip into recession, with GDP contracting by close to 5 per cent."  On more detailed assessment, EBRD says that: "In Russia, lower oil prices have compounded the effect of deep-seated structural problems, increased uncertainty and low investor confidence, along with the increasing impact of economic sanctions imposed since March 2014. In the first three quarters of 2014 investment continued to decline, consumption growth decelerated to below 1 per cent, and imports dropped by 6 per cent in real terms. Capital outflows more than doubled to an estimated US$ 151 billion in 2014. As a result, the rouble has lost almost half of its value in 2014 vis-à-vis the US dollar and Russia lost about a quarter of its international reserves, ending the year at around US$ 380 billion (including the less liquid National Welfare Fund). Markets were particularly shaken in late November/early December 2014, and the central bank had to raise its policy rate to 17 per cent to stem pressure on the currency. The government provided additional capital to a number of banks, temporarily relaxed certain prudential requirements for banks, and introduced measures to increase the supply on the foreign exchange markets by state-owned companies and put in place additional incentives for de-offshorisation."

An interesting footnote to the analysis is covering remittances from Russia. "Remittances from Russia to Central Asia and the EEC continued to decline (see Chart below). Partial data for the fourth quarter in 2014 suggest that the decline is likely to have accelerated in recent months, entering two-digit percentage rate territory, as the Russian economy weakened and the sharp drop in the value of the rouble reduced the US dollar (and also local currency) value of the remitted earnings. Lower remittances inflows will affect consumption adversely and likely add to downward pressures on a number of currencies in EEC and Central Asia, which also face reduced export demand and investment flows from Russia."

Crucially, EBRD forecasts also reflect downgrades on September 2014 outlook. EBRD now estimates 2014 growth to be at 0.4% (more gloomy than IMF estimate and down on 9.6% estimate at the end of Q3 2014), with a contraction of 4.8% in 2015, which represents a downgrade of 4.6 percentage points from September forecast. EBRD oil price assumption is around USD57-59 per bbl.

Chart below summarises unemployment trend 2013-2014:

23/1/2015: A Liquidity Fix for the Euro? What for?...

So Euro area needs liquidity... sovereign liquidity, right?

Take a look at the latest Eurostat data:

Even after all statistical 'methodology' re-jigging and re-juggling, Q1-Q3 2014 saw Government spending accounting for 49.5% of GDP and deficit averaged 2.43% of GDP. Meanwhile, debt/GDP ratio stood at 92.1% of GDP excluding inter-governmental loans (2.4% of GDP):

Yields on Government bonds are hitting all-time lows, including for 'rude health' exemplars such as Spain and Italy:

(credit @Schuldensuehner )

Clearly, liquidity is not  a problem for European sovereigns. But pumping in more liquidity into the euro system might just become a problem: the lower the yields go, the higher the debt climbs. With this, the lower will be the incentives for structural reforms, and the higher will be the debt overhang. All the while, without doing a ditch to repair the actual crisis causes: excessive legacy debts in the households' and corporates' systems.

Meanwhile, the press is lavishing praise on the ECB's Mario Draghi for... well I am not quite sure what is being praised: Mr Draghi is planning on doing in March 2015 what the Fed, BofE, and BoJ have been doing since (on average) 2009, albeit he is facing German (and others') opposition.

Being 6 years too-late into the game, Mr Draghi, therefore, is equivalent to a lazy and tardy student who finally showed up for the class after all other students have left, but bearing an elaborate excuse for not doing his homework.

Thursday, January 22, 2015

22/1/2015: Don't Put Too Much Dosh on ECB's QE Dark Horse...

Today's ECB announcement of EUR60 billion per month from march 2015 through September 2016 QE aiming to take the ECB balance sheet up to EUR1.14-1.26 trillion (estimated, based on starting timing and treatment of 12% share of European institutions securities) has been dubbed a massive boost to the euro area, a watershed, a drastic measure and so on.

Official details are here:

In truth, it is neither.

Quantum of Asset Purchases and Types of Assets

  • Monthly EUR60 billion. This is lower (at current EUR valuations) than 'tapering' levels of Fed purchases (USD75 billion) and is lower than BofE interventions in 2009 which run at STG25 billion / month because EUR60bn ECB intervention is ca 7% of Euro area GDP, while BofE intervention was ca 20% of GDP.
  • Monthly purchases will combine public and private sector securities. Which means the QE is really an add-on to ABS. Purchases will start in the secondary markets and will cover investment grade securities issued by the euro area governments and agencies and European institutions in the secondary market. The key objective is to 'inject new liquidity' to improve liquidity supply. Problem is: with majority of Government bonds in negative yields territory already, where is the targeted shortage of liquidity in the system? I can't find one.
  • Limitation to investment grade cuts out Cyprus and Greece, but the ECB promised to include them into the programme under extended rules.
  • Government and euro area agencies securities will be purchased on the basis of risk-sharing. Quantum of purchases will be proportional to Eurosystem shares of each National Central Bank (NCB). 
  • For European institutions-issued securities,amounting to 12% of total purchases, 80% of purchased quantum to be held on NCB balance sheet, 20% on ECB balance sheet. The latter measure prompted some analysts to conclude that risks can be amplified for the already indebted sovereigns. But this is nonsensical for two reasons: 1) NCBs are part of the Eurosystem, and 2) NCBs will purchase liabilities of the state, so only risk attached to these liabilities is carried through. In simple terms, there cannot be any double liability, just in the same way as one cannot eat the same slice of cake twice. More fundamentally, liabilities of the NCBs do not have to match the NCBs assets, nor do they constitute a claim on NCBs assets. Here is an informative primer on the topic:
  • For National securities, there will be no risk sharing. So risk sharing only applies to Agencies-issued debt.
  • As a part of QE announcement, the ECB has also altered the set up of the TLTROs (there are six more tranches of these forthcoming). TLTROs will now be priced at MRO set at the time of each TLTRO tranche. This will lower the cost of future TLTRO tranches by some 10 bps. Net result - TLTROs are now marginally more attractive.
  • The ECB can cut short the asset purchasing programme if there is a signal of 'sustained improvement in inflation'.

Impact Assessment:

The measures are sign of desperation and frustration on ECB behalf. And not with the persistence of deflationary risks.

Instead, QE announcement was accompanied by another round of 'fighting' rhetoric from Draghi, who clearly continues to push member states and the European Commission to aggressively pursue structural markets reforms.

Draghi downplayed expectations for QE by stressing that QE only provides conditions to support growth. In his own words: "Monetary policy can create basis for growth but it's up to governments and Commission to make sure growth actually takes place". In so far as absent growth there won't be inflation, we, therefore, have a perfect excuse ex ante for any QE failure.

The key, however, is that we are now into the unchartered territory of watching the emergence of the second round effects of QE announcement.

The reason for this is that the direct impact - lowering Government borrowing costs - is effectively useless - the euro area as a whole is already enjoying record low yields. Meanwhile, market expectations of inflationary pressure over the longer horizon (e.g. 5yr/5yr spreads) are starting to price higher inflation, albeit modestly so.

Mr Draghi's claim that the measure is aimed at supplying liquidity is a red herring - a token nod to the German hawks. In reality, most likely, the QE will not unleash a wave of new credit creation.

More likely, we shall see some easing of deflationary risks, with inflation picking up in the medium term on foot of both QE and oil prices reversion back toward fundamentals-justified levels. Euro devaluation will also help to cover up underlying structural drivers for deflationary risks.

The real causes of deflationary risks in the euro area is weak demand. The latter is driven by collapse in after-tax household incomes and savings, and by the ongoing deleveraging of the households and firms. None of these can be helped by the QE.

Meanwhile, the QE is likely to provide some easier conditions for issuance of new Government debt. Currently, just under 50% of the euro area economy is accounted for by the Government spending. Pumping more spending into this economy is unlikely to do much for future growth and is hardly going to trickle down to the ordinary households. Which means that the entire QE exercise is dubious in nature. It will, however, significantly pads the pockets of bonds dealers and stock markets, and banks that hold these securities.

One caveat few noticed is that the ABS segment of the QE programme now falls under the remit of the NCBs. Which means that national authorities can select assets for purchases from the private sector. How this mechanism can prevent selection biases to, say, potentially favour so-called National Champions (larger state-owned entities and private monopolies) or corrupt selection of politically-connected enterprises and other similar behaviour is anyone's guess.

The circus surrounding the ECB announcement was (and remains) quite bizarre. The ECB announced effectively new (as in unknown to us before) measures to the quantum of roughly EUR114-260 billion, since it already previously set a target of ca EUR1 trillion balance sheet expansion.

Even more bizarrely, we know many details of the QE mechanism, but we have no idea as to the split between the sovereign bonds purchases and private asset purchases. We have no defined limit to the balancesheet expansion and we do not have a defined process for ending the programme (sudden stop or tapering).


As I tweeted today, a viable alternative to the largely dubious QE would have been supporting household incomes and companies investment. This can be done more effectively via targeted and structured tax policies that are medium-term revenue neutral. One example, coincidentally, provided today in FT by Martin Feldstein:

In the medium term, the key should be using monetary policy and fiscal policy to deleverage the economies: households, companies and governments. This is not being helped by the QE. Here is an interesting recent paper on the subject:

In the long run, the key is finding real new catalysts for growth in the euro area that can compensate for the structural and demographic declines the EMU economies are suffering from. This too is not being helped by the QE.

Update 1: Here is the proportion by which ECB will allocate purchasing allowances for each NCB:

Update 2: And here is yet another reason why ECB's QE might not be the 'big bazooka' that will end markets fragmentation (aka increase credit supply to the real economy) - read bottom tweet first:

Courtesy of @Lee_Adler

22/1/2015: Some recent stats on Russian economy

Couple of recent stats for Russian economy:
  • Federal Budget Deficit for 2014 full year was 0.5% of GDP or RUB328 billion (ca USD 5 billion). Meanwhile, the Cabinet prepared a new Budgetary plan for dealing with the crisis which includes RUB 1.375 trillion (USD21 billion) worth of new measures. Amongst reported changes: RUB 250 billion worth of state banks recaps funds via the National Wealth Fund; RUB 86 billion of new subsidies for agriculture, industry and health, plus some regional tax breaks for SMEs.
  • As reported by the Russia Insider ( Russian banks dramatically increased bad loans provisions in 2014, up 42.2% y/y compared to 16.8% growth in 2013. Based on Sberbank estimates, if oil averaged USD40/pbl over 2015, Russian banks provisions will have to rise some USD46 billion. Meanwhile, banks profits run some 40% below 2013 levels. In 2012, Russian banks profits stood at RUB 1 trillion (USD15.3 billion), and in 2013 profits were RUB 994 billion (USD15.2 billion). In 2014 banks profits fell to RUB 589 billion (USD9 billion). Ugly numbers.
  • Rental values for Moscow apartments were all over the shop in Q4 2014: Economy Class average rental rate in Rubles rose 1.1% q/q despite reports of falling demand from the migrants, while Comfort Class average rentals were down 1% q/q. Business Class rental values were up 0.71% q/q, but Elite Class rentals were down massive 11.5% q/q. So mixed signals from the rental markets overall. 

Wednesday, January 21, 2015

21/1/2015: Ukraine Requests Extended Fund Facility from the IMF

So Ukraine made a (formal?) request for change in the IMF lending programme:

Of all places... in Davos. And Ms Lagarde is dead-pan sure that an agreement to proceed will follow from the IMF Executive Board... not that anyone could doubt that it will, but it might be a better tone not to jump ahead.

The quantum of funding requested is not known, but we already know that Ukraine's own estimates were USD15 billion back in November 2014. Since then, things did not improve, so the same figure is probably closer to USD18 billion. And I suspect that Ukraine will need at least USD20-25 billion over 2015-2017, even under rather positive assumptions.

I do hope they get a good rate on all this borrowing, as loans do require interest payments and principal repayments.

21/1/2015: ECB QE: Risk-Sharing or Risk-Dumping?

My comment for Expresso (January 17, print edition page 12) on what to expect from ECB next.

Given the deflationary dynamics, including the 5y/5y swap at below 1.50 and the first negative reading since 2009, there is a strong pressure on ECB to act. Crucially, this pressure is directly link to the ECB mandate. Additional momentum pointing toward ECB adopting a much more pro-active stance this month comes from the euro area leading growth indicators. Ifo's Economic Climate for the Euro Area continued to deteriorate in the Q4 2014 and January Eurozone Economic Outlook points to effectively no improvement in growth prospects in Q1 2015 compared to Q4 2014. Eurocoin indicator showed similar dynamics for December 2014.

At this stage, even the ECB hawks are in agreement that some monetary easing action is required and most recent comments from the ECB Governing Council members strongly suggest that there is strong momentum toward adopting a sovereign bonds purchasing programme.

The question, therefore, has now shifted toward what form will such a programme take.

Indications are, the ECB will opt for a programme that will attempt to separate risk of default from market risks. Under such a programme, the risk of sovereign default will be vested with the National Central Bank (NCB) of the bonds-issuing country, while the ECB will carry the market pricing risks.

The problem is that such a programme will directly spread the risk of fragmentation from the private sector financial system to the Eurosystem as a whole. If the NCBs carry direct risks (in full or in part) relating to sovereign default, the entire Eurosystem will no longer act as a risk-sharing mechanism and will undermine the ECB position as a joint and several institution.

Another problem is that if risks are explicitly shared across the ECB and NCBs, the ECB will become a de facto preferred lender, with rights in excess of NCBs and, thus, above the markets participants. Any other arrangement will most likely constitute a fiscal financing and will violate the restrictions that prevent non-monetary financing.

These twin problems imply that, unless the ECB fully participates in risk sharing with the NCBs, the QE programme will risk inducing much greater risk of repricing in the 'peripheral' euro states and thus can lead to greater fragmentation in the markets.

21/1/2015: Global Trade Indicators Flashing Red

Two very interesting charts reflecting upon the same macroeconomic reality: world trade is slowing down. Big time…

First, IMF revisions of the global trade growth rates forecasts for 2015 - now at their lowest in 12 months (chart courtesy of the @zerohedge):

And next, Baltic Dry Index series printing 753,000 currently, a level consistent with depths of 2009 crisis and 2012-2013 slump (chart courtesy of @Schuldensuehner) :

All in, the above highlights the powerless nature of large scale advanced economies' QE measures when it comes to reigniting global demand.

Saturday, January 17, 2015

17/1/2015: Is QE permanent and do we need a Government debt 'deletion'?

In a far-reaching comment on the QE and its true nature, published back in 2013 (see here:,  Ambrose Evans-Pritchard took the arguments of several economists and drew, with them, a very far reaching set of conclusions.

To summarise these:
1) QE is permanent - it cannot be undone. I agree.
2) Better than that, QE should be used to cancel legacy Government debts, providing deficit financing ex post facto. I agree only partially.
3) QE should be expanded to a stand by facility to fund aggregate demand via funding future deficits. I disagree.

Why would I disagree with the 2 latter points?

Reason 1: Government debt is not the biggest problem shared by all economies today. In some economies, such as Greece, Italy and US, for example, it is the main problem. But in other economies, such as Ireland and Spain, for example, it is secondary to household and corporate debts. This means that even if economic growth restarts on foot of the above 3-points plan, the reversion to 'normalcy' in interest rates will simply crash legacy debt-holders. No amount of fiscal stimulus will be able to undo this damage.

Reason 2: Government deficits and debts did not arise from purely automatic stabilisers (or in simple terms solely from the disruptions caused by the Global Financial Crisis) in all economies. In some countries they did, as, for example in Italy and France. In others, they came about as the result of imbalances in the economy that drove large asset bubbles, e.g. Ireland and Spain. In yet other countries they were systemic, e.g. Greece and Italy. The 3-points plan can help the first set of countries. Can do damage to the second set of countries (via interest rates channel and/or by generating another bubble) and will provide no incentives for change for the last set of countries.

There are other arguments as to the fallacious or partially fallacious nature of points 2 and 3. These include the arguments that public spending creates own bubbles - those in wages and salaries, employment and practices in the public sector, or those in rates of return for politically connected businesses or those in public infrastructures that will have to be maintained and serviced over decades to come, irrespective of the economic returns they might generate. They also include the arguments that public spending and investment can crowd out private spending and investment. As well as arguments that in a number of countries, especially within the euro area, public spending as already hefty enough and priming it up using monetary financing today is setting us up for creating a permanent future liability to continue funding the same out of tax revenues into perpetuity after the QE funding is completed.

The key, however, is the problem of total debt distribution, not just of Government debt volumes. A 'delete' button must be pushed, I agree. But what we will be deleting has to be much more complex than just the Government debt. In some countries it will have to also include private debts. And for that, we have not had a QE devised, yet...

17/1/2015: Russian Capital Flight: What Western 'Analysts' Forget

Central Bank of Russia released full-year 2014 capital outflows figures, prompting cheerful chatter from the US officials and academics gleefully loading the demise of the Russian economy. 

The figures are ugly: official net outflows of capital stood at USD151.5 billion - roughly 2.5 times the rate of outflows in 2013 - USD61 billion. Q1 outflows were USD48.2 billion, Q2 outflows declined to USD22.4 billion, Q3 2014 outflows netted USD 7.7 billion and Q4 2014 outflows rose to USD72.9 billion. Thus, Q4 2014 outflows - on the face of it - were larger than full-year 2013 outflows.

There are, however, few caveats to these figures that Western analysts of the Russian economy tend to ignore. These are:
  • USD 19.8 billion of outflows in Q4 2014 were down to new liquidity supply measures by the CB of Russia which extended new currency credit lines to Russian banks. In other words, these are loans. One can assume the banks will default on these, or one can assume that they will repay these loans. In the former case, outflows will not be reversible, in the latter case they will be.
  • In Q1-Q3 2014 net outflows of capital that were accounted for by the banks repayment of foreign funding lines (remember the sanctions on banks came in Q2-Q3 2014) amounted to USD16.1 billion. You can call this outflow of funds or you can call it paying down debt. The former sounds ominous, the latter sounds less so - repaying debts improves balance sheets. But, hey, it would't be so apocalyptic, thus. We do not have aggregated data on this for Q4 2014 yet, but on monthly basis, same outflows for the banking sector amounted to at least USD11.8 billion. So that's USD 27.9 billion in forced banks deleveraging in 2014. Again, may be that is bad, or may be it is good. Or may be it is simply more nuanced than screaming headline numbers suggest.
  • Deleveraging - debt repayments - in non-banking sector was even bigger. In Q4 2014 alone planned debt redemptions amounted to USD 34.8 billion. Beyond that, we have no idea is there were forced (or unplanned) redemptions.

So in Q3-Q4 2014 alone, banks redemptions were scheduled to run at USD45.321 billion and corporate sector redemptions were scheduled at USD72.684 billion. In simple terms, then, USD 118 billion or 78 percent of the catastrophic capital flight out of Russia in 2014 was down to debt redemptions in banking and corporate sectors. Not 'investors fleeing' or depositors 'taking a run', but partially forced debt repayments. 

Let's put this into a slightly different perspective. Whatever your view of the European and US policies during the Global Financial Crisis and the subsequent Great Recession might be, one corner stone of all such policies was banks' deleveraging - aka 'pay down of debt'. Russia did not adopt such a policy on its own, but was forced to do so by the sanctions that shut off Russian banks and companies (including those not directly listed in the sanctions) from the Western credit markets. But if you think the above process is a catastrophe for the Russian economy induced by Kremlin, you really should be asking yourself a question or two about the US and European deleveraging policies at home.

And after you do, give another thought to the remaining USD 33 billion of outflows. These include dollarisation of Russian households' accounts (conversion of rubles into dollars and other currencies), the forex effects of holding currencies other than US dollars, the valuations changes on gold reserves etc.

As some might say, look at Greece… Yes, things are ugly in Russia. Yes, deleveraging is forced, and painful. Yes, capital outflows are massive. But, a bit of silver lining there: most of the capital flight that Western analysts decry goes to improve Russian balancesheets and reduce Russian external debt. That can't be too bad, right? Because if it was so bad, then... Greece, Cyprus, Spain, Italy, Ireland, Portugal, France, and so on... spring to mind with their 'deleveraging' drives...

17/1/2015: Russia is not Greece...

On foot of sovereign downgrade of Russian debt back on January 10, Fitch cut ratings for some Russian regions and banks last night.

Here's Interfax link to banks downgrades: and regional ratings downgrades:

Note: Moody's also issued a sovereigns bet downgrade for Russia - details here:

Meanwhile, another downgrade is coming - S&P said yesterday that it will review Russian ratings before the end of January. Interfax report here:

The season of 'Get Russia' continues. With uninterrupted success… oh yes, the dim sum markets will be fun in 2015.

Note: I must say I have not seen such rapid fire downgrading any time in my memory, with exception of Greece and Cyprus where, in both cases, the ratings agencies were literally racing each other and themselves to catch up with the reality.

Friday, January 16, 2015

16/1/2015: Moody's Get Double Moody on Russia

As I predicted at a briefing earlier today, Moody's downgraded Russia's sovereign debt (expect downgrades of banks and corporates to follow in due course). This was inevitable given the outlook for growth 'dropped down' on us by the agency in their note on Armenia (see here).

Full release on downgrade is here:

The point is - if you believe Moody's outlook for the risks faced by the economy - you should expect full, open (as opposed to partial and 'voluntary') capital controls and debt repayments holidays (for corporate and banks' debts for entities directly covered by sanctions) before the end of the year.

And, you should still expect a good 75%+ chance of a further downgrade upon the review as Moody's struggle to push ahead with projecting a more 'robust ratings' stance to the markets.

Even the best case scenario is for another downgrade and 12-18 months window of no positive reviews.

The impact of these downgrades is narrow, however. Russian Government is unlikely to become heavily dependent on new debt issuance and thus is relatively well insulated against the fall out from the secondary bond market yields spikes. Russian banks can withstand paper losses on sovereign bonds they hold. At any rate they have much greater headaches than these - if oil prices follow Moody's chartered course, who cares what sovereign ratings are assigned. The impact of sovereign ratings and yields on private debt issuance is a bit more painful, as it will hit those entities issuing new debt in dim sum markets, but again, the overall impact is secondary to the bigger issues of sanctions and the freezing of the debt markets for Russian entities.

On the other hand, were the downgrades and markets reaction to push Russians over the line into direct capital controls and suspension of debt redemptions and servicing for entities affected by the sanctions, the impact on Western debt holders will be painful. And the sovereign deficits and debt positions will be fully covered by sovereign reserves.

So the more real the Moody's risks prognosis becomes, the more pain will be exported from Russia our way.

16/1/2015: Universal Basic Income v Unemployment Insurance

The idea of a universal basic income (UBI) has been in the news recently primarily because of the Swiss referendum on the topic, but also because it is gang traction as a functional substitute for the existent systems of social welfare provision.

An interesting recent paper by Fabre, Alice and Pallage, Stephane and Zimmermann, Christian, titled "Universal Basic Income versus Unemployment Insurance" (December 18, 2014, CESifo Working Paper Series No. 5106: compared "…the welfare effects of unemployment insurance (UI) with an universal basic income (UBI) system in an economy with idiosyncratic shocks to employment."

On positive side, both policies "provide a safety net in the face of idiosyncratic shocks. While the unemployment insurance program should do a better job at protecting the unemployed, it suffers from moral hazard and substantial monitoring costs, which may threaten its usefulness." Much of these effects are addressed through rather disruptive and painful 'labour market activation reforms' that commonly coincide with periods of elevated unemployment, thus inducing even greater personal, social and economic hardship.

The authors conjecture, in line with much of theoretical and empirical literature, that "The universal basic income, which is simpler to manage and immune to moral hazard, may represent an interesting alternative in this context."

The study calibrates an equilibrium model with savings to data for the United States for 1990 and 2011. The results "…show that UI beats UBI for insurance purposes because it is better targeted towards those in need."

16/1/2015: Where did Greek 'bailout' funds go?

Given the gyrations of the Greek crisis or crises, it might be handy to get a handle on where all the bailout funds extended to Greece have gone. Here are two charts illustrating the said:

Update: source for the charts data: and my own calculations based on the same.

So in simple terms, Government debt 'solutions' took up 133 billion euros of 'rescue' funds - much of this going to the private sector foreign holders of bonds (PSI) and to private investors in bonds (many foreign) via interest and redemptions. Banks chewed through another 83 billion euros. Total of 81 percent of the funds went to these liabilities.

The fabled Greek deficits (careless spending meme et al) got only 6 percent of the total allocations, of which a small share went to, undoubtedly, support the 'most vulnerable'.

16/1/2015: Moody's expect Russian GDP growth of -5.5% in 2015

Moody’s Investors Service, expects Russian GDP to post a decline of 5.5 percent in 2015.

The forecast comes via Moody's note on Armenia in which the agency downgraded Armenian debt to Ba3 from Ba2 and cut outlook from stable to negative.

Per Moody's: "The key drivers for the downgrade are the following:

1) Armenia's increased external vulnerability due to declining remittances from Russia, an uncertain outlook for foreign direct investment (FDI), an elevated susceptibility to exchange rate volatility, and expected pressure on foreign exchange (FX) reserves;

2) The country's impaired growth outlook, compounded by negative growth spillovers from Russia, weak investment activity, and constraints on trade with countries outside the Eurasian Economic Union (EEU) that are expected from Armenia's recent EEU accession."

Moody's note:

According to Moody's "Remittances represent about 15% of GDP, with over 90% of the total stemming from Russia."

More on the remittances from Russia to other CIS and former USSR states here:

16/1/2015: S&P Capital IQ Global Sovereign Debt Report: Q4 2014

S&P Capital IQ’s Global Sovereign Debt Report is out for Q4 2014, with some interesting, albeit already known trends. Still, a good summary.

Per S&P Capital IQ: "The dramatic fall in oil prices dominated the news in Q4 2014, affecting the credit default swaps (CDS) and bond spreads of major oil producing sovereigns which have a dependence on oil revenues. Venezuela, Russia, Ukraine, Kazakhstan and Nigeria all widened as the price of oil plummeted over 40%. Separately, Greece also saw a major deterioration in CDS levels as it faces a possible early election."

And "Globally, CDS spreads widened 16%."

No surprises, as I said, but the 16% rise globally is quite telling, especially given CDS and bond swaps for the advanced economies have been largely on a downward trend. The result is: commodities slump and dollar appreciation are hitting emerging markets hard. Not just Russia and Ukraine, but across the board.

Some big moves on the upside of risks:

  • "Venezuela remains at the top of the table of the most risky sovereign credits following Argentina’s default in Q3 2014, resulting in its removal from the report, with spreads widening 169% and the 5Y CDS implied cumulative default probability (CPD) moving from 66% to 89%." 
  • The only major risk source, unrelated to commodities prices is Greece where CDS spreads "widened to 1281bps - an election as early as January could see a change of government and fears over a possible exit from the Eurozone have affected CDS prices." 
  • "Russia enters the top 10 most risky table as CDS spreads widened around 90% following the fall in oil price which is adding more pressure to an economy already subject to continued economic sanctions." 
  • "Ukraine CDS spreads also widened by 90%." 
  • "CDS quoting for Nigeria remained extremely low throughout the last quarter of 2014. Bond Z-Spreads widened 150bps for the Bonds maturing in January 2021 and July 2023 but remained very active." 

Venezuela and Ukraine are clear 'leaders' in terms of risks - two candidates for default next.

Other top-10 are charted over time below:

Again, per S&P Capital IQ:

  • "The CDS market now implies an 11% probability (down from 34% in Q3 2014) that Venezuela will meet all its debt obligations over the next 5 years, as oil prices dropped 40% in Q4 2014." 
  • "Russia and Ukraine CDS spreads widened 90% during Q4 2014. The Russia CDS curve also inverted this quarter with the 1Y CDS level higher than the 5Y. Curve inversion occurs when investors become concerned about a potential ‘jump to default’ and buy short dated as opposed to 5Y protection." This, of course, is tied to the risks relating to bonds redemptions due in H1 2015, which are peaking in the first 6 months of the year, followed by still substantial call on redemptions in H2 (some details here: As readers of the blog know, I have been tracking Russian and Ukrainian CDS for some time, especially during the peak of the Ruble crisis last month - you can see some comparatives in a more dynamic setting here: and in precedent links, by searching the blog for "CDS".
  • "Greece, which restructured debt in March 2012, returned to the debt markets this year. CDS spreads widened to 1281bps and the 4.75Y April 2019 Bonds, which were issued with a yield of 4.95%, now trade with a yield of over 10%, according to S&P Capital IQ Bond Quotes." 

By percentage widening, the picture is much the same:

So all together - a rather unhappy picture in the emerging markets - a knock on effect of oil prices collapse, decline across all major commodities prices, dollar appreciation and the risk of higher US interest rates (the last two factors weighing heavily on the risk of USD carry trades unwinding) - all are having significant adverse effect across all EMs. Russia is facing added pressures from the sanctions, but even absent these things would be pretty tough.

Note 1: latest pressure on Ukraine is from the risk of Russia potentially calling in USD3 billion loan extended in December 2013. Kiev has now breached loan covenants and as it expects to receive EUR1.8 billion worth of EU loans next, Moscow can call in the loans. The added driver here (in addition to Moscow actually needing all cash it can get) is the risk that George Soros is trying to get his own holdings of Ukrainian debt prioritised for repayment. These holdings have been a persistent rumour in the media as Soros engaged in a massive, active and quite open campaign to convince Western governments of the need to pump billions into the Ukrainian economy. Still, all major media outlets are providing Soros with a ready platform to advance his views, without questioning or reporting his potential conflicts of interest. 

Note 2: Not being George Soros, I should probably disclose that I hold zero exposures (short or long) to either Ukrainian or Russian debt. My currency exposure to Hrivna is nil, to Ruble is RUB3,550 (to cover taxi fare from airport to the city centre on my next trip). Despite all these differences with Mr Soros, I agree that Ukraine needs much more significant aid for rebuilding and investment. Only I would restrict its terms of use not to repay billionaires' and oligarchs' debts but to provide real investment in competitive and non-corrupt enterprises.

Thursday, January 15, 2015

15/1/2015: Upbeat German Data Might Not Be a Boom Signal for Europe

So German economy expanded 1.5% in 2014 and managed a budget deficit of just 0.4% of GDP. That's the latests numbers and they are beating performance since 2011. Which is good news.

Except for the bad news. Take a look at CES-Ifo data on current economic conditions and forward 6 months expectations.

Chart 1:

Per chart above, euro area assessments of own performance over 2014 were upbeat compared to Germany. The outrun is euro area economy under-performed Germany in the end. And forward:

Chart 2:

Euro area forward expectations remain also upbeat through Q3 2014 on 6 months forward basis. Which turned into downbeat print in Q4. But they remain upbeat through Q1 2015. And taking in the economy print for Germany for 2014, this suggests that euro area will be disappointing on growth over the next 3 months. Thereafter, either Germany will reignite euro area growth (option 1) or continue expanding without much of a response from the euro area (option 2)

What's more likely? Since 2010 through present, 6mo forward expectations in the euro area have been posting much shallower correlation with 6mo forward expectations in Germany (+0.56) than over pre-crisis period (0.66 for 2000-2007 and 0.70 for 1991-2000).  And these are taking Germany into account in euro area data.

Which suggests option 2 is likelier.

So it's Germany 1: Rest of EMU 0.5. Things are more worrying than 1.5% growth 2014 for German economy might imply.

15/1/2015: 2015 Outlook for Ireland: Domestic Bliss & Foreign Squeeze

This is an unedited version of my article for the Village Magazine, January 2015 (link here)

December data on Irish economy is painting a picture of a major slowdown in growth momentum and once more highlights the troubling nature of our national accounts statistics. With that in mind, and given the spectacular tremors rocking the global economy outside the well-insulated doors of our Department of Finance, Irish economy is set for an eventful 2015.

Let’s take stock of the prospects awaiting our small haven for tax-optimising MNCs and regulations-minimising foreign investors in the New Year.

Domestic Bliss

On domestic front, three drivers of economic recovery are offering some fireworks over the next 12 months. Here they are, in order of their importance.

The ongoing shift in MNCs activities here from profit-booking to cost-based transfer pricing, colloquially known as ‘contract manufacturing’. In simple terms, this means unprofitable low margin activities are outsourced by MNCs to their subdivisions and other MNCs located abroad, and resulting revenues are booked into Ireland. Official GDP rises here, while our domestic economy stands still. In H1 2014 this game of accounting shells has accounted for 2.5 percent of the 5.8 percent recorded growth in Irish GDP. In other words, some 43 percent of the growth ‘miracle’ that is Ireland Inc. was bogus. We don’t have detailed analysis of Q3 2014 data to determine the broader impact of ‘contract manufacturing’ yet, but the National Accounts data is not encouraging. The gap between the National Accounts-reported exports of goods and the same exports reported in our Trade Statistics is growing once again. Over Q2 and Q3 2014, this stood at a whooping EUR7 billion more than what a historical average implies. That is, roughly, 7.65 percent of our entire GDP over the same period. If we correct National Accounts data for this discrepancy, cumulative Q2-Q3 2014 GDP in Ireland would have posted a 0.4 percent decline year-on-year, not a rise of 5.4 percent recorded in the official statistics.

As the trend accelerates in 2015, Irish economy is likely to post greater paper gains and lower real activity amidst continuously deteriorating quality of our economic data.

The second driver to the upside is also MNCs-focused. Budget 2015 introduced massive incentives for the MNCs to book into Ireland intellectual property. Instead of the notorious Double Irish we now have an even more generous Knowledge Development Box. This reinforces already absurd change to the National Accounts estimation practices that re-labels R&D spending into R&D investment. The combined effect of both factors is likely to be more R&D ‘imports’ into Ireland. Latest data shows that overseas-originating patents filled in Ireland rose 22.4 percent year on year in Q3 2014. And that is before the ‘Knowledge Development Box’ opened its welcoming lid. As 2015 rolls on, expect more GDP supports from the new ‘investment’ products to hit the market here. Just don’t count on new jobs and higher domestic incomes to materialise out of this ‘smart economy’ any time soon.

The third force likely to propel Irish growth to new highs is the ongoing squeeze on building and construction sector imposed by a combination of a credit crunch, Nama assets-disposal strategy and woefully poor regulatory reforms that de facto cut down supply of buildable land and redevelopment sites, funding for development and dried out planning applications pipeline. The result is rising rents (GDP-additive) and prices (so-called ‘investment’ side of the national accounts) amidst deepening misery of rising business costs and escalating cost of living. Added up, Irish property sector ‘revival’ is now yet another force that simultaneously transfers money from the households and firms into the pockets of rent-seekers and the Government, whilst gilding with fools gold national accounts.

Foreign Squeeze

The domestic bliss of GDP growth described above will be severely challenged in 2015 by the continued deterioration in the global economic conditions. Here we have some serious flash points of risks, trailing back from 2013-2014 and some new ones that are likely to emerge in 2015 on their own right.

Back at the beginning of 2014, expectations for global growth recovery in 2015 were driven by rosy forecasts for North America and the Emerging Markets.

Euro area was expected to post rather sluggish, but nonetheless above 1 percent recovery in 2014 and rise to close to 2 percent annual growth rate in 2015. Fast forward to today. Latest forecasts suggest near-zero growth in 2014 followed by ca 1 percent growth in 2015. So Europe’s prospects are bleak. That’s roughly 35 percent of our indigenous exports trade in the bin. But at least low growth is likely to delay the inevitable rise in interest rates, giving our heavily indebted households another stay on execution.

The U.S. miracle of economic recovery is heavily dependent on interest rates policy not reverting back to rising rates and in all likelihood, the U.S. Fed might just oblige. Should the Fed change its mind, all bets are off: we might see a slowdown in the U.S. recovery and with it – a fall-off in the U.S. demand for Irish exports, both indigenous ones and MNCs’.

The UK is a great example of the fragility also present in the U.S. economy. Like the U.S., the UK is heavily dependent on supportive monetary policy. And, ahead of the U.S., its economy is starting to hit serious bumps. Latest data shows continued declines in house prices, while demand is stagnating and inflation is slipping to long-term lows. Last time we saw UK inflation at current levels was in 2002 – amidst the bubble-induced recession.

Take U.S. and UK markets and we have over 50 percent of demand for Irish indigenous exports put under rising risk.

Which leaves us with the rest of the world. Here, the Emerging Markets are tanking, fast. Brazil is in an outright recession. Russia is slipping into one at a speed of a rock falling through the foggy ravine. China is on the brink of a major de-acceleration in growth, and that is under rather rosy predictions. India is enjoying some warm afterglow of expansionary monetary policies, but the question is – for how long. South Africa is moving sideways: a quarter of contraction is followed by a quarter of anemic growth.

Irish Government Budget 2015 projections were based on following assumptions:
-       Irish GDP growth of 3.9 percent or 0.85 percentage points above the IMF forecast from October and 0.6 percentage points below November forecasts by the OECD
-       Euro area growth of 1.1 percent or bang on with IMF and OECD forecasts, as well as the EU Commission, but the risks are still to the downside in all of these forecast.
-       U.S. growth of 3.1 percent, virtually identical to the IMF forecast and current consensus amongst the economists, but some business surveys suggest growth closer to 2.4-2.5 percent.
-       UK growth of 2.8 percent or 0.1 percentage points above the IMF forecast from October and OECD forecast from November. More recent forecasts published in early December suggest UK economy might expand by 2.4-2.6 percent in 2015.

Global headwinds are not favourable to Ireland, although we do have some aces in our sleeve. These aces are: aggressive tax optimisation and already suppressed domestic demand, the two drivers that might, just might return that 3.9 percent expansion in 2015.

Still, for now, the forecasts arithmetic suggests that the Government really did miss a major opportunity in Budget 2015. You see, the pesky problem is, as the Irish Fiscal Advisory Council estimates show, Irish growth at 3.5 percent in 2015 will mean the Government missing on the illusive 3 percent deficit target. As the above forecasts slip back over time, the 3.9 percent growth assumption is likely to be revised closer and closer to that critical point at which the Government risks losing face in front of the proverbial International Markets. And that won’t go too well in the Government buildings.

Add to the above some other silly assumptions made in the Budget, such as static current expenditure for 2015-2018 horizon and zero policy change, and you get the idea. Over recent months, the Government has revised its spending plans in relation to Irish Water by some EUR300 million. And over the next 12 months it will have to revise its agreements with the Trade Unions on public sector costs moderation. Then, there is the political cycle that simply commands that the Government unleash a torrent of budgetary giveaways onto electorate itching to send the FG/Labour coalition into the proverbial recycling bin of history.

All told, the real economy is likely to continue underperforming into 2015, just as it did in 2014. In the first 3 quarters of this year, total domestic demand (a sum of private and public consumption and investment, plus changes in the stocks of goods and services in the economy) was up just 2.18 percent year on year in real terms. Over the last three years, covered by the current Government policies, total domestic economic activity has expanded by a miserly 0.29 percent in real terms. That is less than half the rate of growth in GDP over the same period. And the latest quarter has been even less impressive, with domestic demand falling 0.3 percent year on year, same as in Q3 2013.

So tighten those belts for one more year of pain: the slimming down of Irish economy is not over yet.