2/2/15: Russian External Debt: Falling & So Far Sustainable

BOFIT published an update on Russian external debt as of the end of December 2014. The update shows the extent of debt deleveraging forced onto Russian banks and companies by the sanctions.

In H2 2014, repayments of external debt accelerated.

Banks cut their external debt by USD43 billion to USD171 billion over the year, with much of the reduction coming on foot of two factors: repayment of maturing debt and ruble devaluations. Ruble devaluations - yes, the ones that supposed to topple Kremlin regime - actually contribute to reducing Russian external debt. Some 15% of banks' external debts are denominated in Rubles.

Corproate external debt fell by USD60 billion to USD376 billion, with Ruble devaluation accounting for the largest share of debt decline, as about 25% of all external corporate debt is denominated in Rubles.

So do the maths: Ruble devaluations accounted for some USD16 billion drop in banks debts, and some USD54 billion in corporate debt in 2014 (rough figures as these ignore maturity of debt composition and timing).

Additional point, raised on a number of occasions on this blog, is that about 1/3 of corporate debt consists of debt cross-held within corporate groups (loans from foreign-registered parent companies to their subsidiaries and vice versa).

All in, end-2014 external debt of Russian Government, banks and corporates stood at USD548 billion, or just below 30% of GDP - a number that, under normal circumstances would make Russian economy one of the least indebted economies in the world. Accounting for cross-firm holdings of debt, actual Russian external debt is around USD420 billion, or closer to 23% of GDP.


CBR latest data (October 2014) puts debt maturity schedule at USD108 billion in principal and USD20 billion in interest over 2015 for banks and corporates alone. Of this, USD37 billion in principal is due from the banks, and USD71 billion due from the corporates. Taking into the account corporates cross-holdings of debt within the enterprise groups, corporate external debt maturing in 2015 will amount to around USD48 billion. Against this, short-term banks' and corporate deposits in foreign currency stand at around USD120 billion (figures from October 2014).

In other words, Russian banks and companies have sufficient cover to offset maturing liabilities in 2015, once we take into the account the large share of external debts that are cross-held by enterprise groups (these debts can be easily rolled over). Of course, the composition of deposits holdings is not identical to composition of liabilities, so this is an aggregate case, with some enterprises and banks likely to face the need for borrowing from the CBR / State to cover this year's liabilities.

BOFIT chart summarising:

26/1/16: Russian External Debt: Deleveraging Goes On

In previous post, I covered the drawdowns on Russian SWFs over 2015. As promised, here is the capital outflows / debt redemptions part of the equation.

The latest data for changes in the composition of External Debt of the Russian Federation that we have dates back to the end of 2Q 2015. We also have projections of maturities of debt forward, allowing us to estimate - based on schedule - debt redemptions through 4Q 2015. Chart below illustrates the trend.

As shown in the chart above, based on estimated schedule of repayments, by the end of 2015, Russia total external debt has declined by some USD177.1 billion or 24 percent. Some of this was converted into equity and domestic debt, and some (3Q-4Q maturities) would have been rolled over. Still, that is a sizeable chunk of external debt gone - a very rapid rate of economy’s deleveraging.

Compositionally, a bulk of this came from the ‘Other Sectors’, but in percentage terms, the largest decline has been in the General Government category, where the decline y/y was 36 percent.

Looking at forward schedule of maturities, the following chart highlights the overall trend decline in debt redemptions coming forward in 2016 and into 2Q 2017.

Again, the largest burden of debt redemptions falls onto ‘Other Sectors’ - excluding Government, Central Bank and Banks.

The total quantum of debt due to mature in 2016 is USD76.58 billion, of which Government debt maturing amounts to just 1.7 billion, banks debts maturing account for USD19.27 billion and the balance is due to mature for ‘Other Sectors’.

These are aggregates, so they include debt owed to parent entities, debt owed to direct investors, debt convertible into equity, debt written by banks affiliated with corporates, etc. In other words, a large chunk of this debt is not really under any pressure of repayment. General estimates put such debt at around 20-25 percent of the total debt due in the Banking and Other sectors. If we take a partial adjustment for this, netting out ‘Other Sectors’ external debt held by Investment enterprises and in form of Trade Credit and Financial Leases, etc, then total debt maturing in 2016 per schedule falls to, roughly, USD 59.5 billion - well shy of the aggregate total officially reported as USD 76.58 billion.


So in a summary: Russian deleveraging continued strongly in 2015 and will be ongoing still in 2016. 2016 levels of debt redemptions across all sectors of the economy are shallower than in 2015. Although this rate of deleveraging does present significant challenges to the economy from the point of view of funds available for investment and to support operations, overall deleveraging process is, in effect, itself an investment into future capacity of companies and banks to raise funding. The main impediment to the re-starting of this process, however, is the geopolitical environment of sanctions against Russian banks that de facto closed access to external funding for the vast majority of sanctioned and non-sanctioned enterprises and banks.


Next, I will be covering Russian capital outflows, so stay tuned of that.

15/8/15: Russian External Debt: Big Deleveraging, Smaller Future Pressures

Readers of this blog would have noted that in the past I referenced Russian companies cross-holdings of own debt in adjusting some of the external debt statistics for Russia. As I explained before, large share of the external debt owed by banks and companies is loans and other debt instruments issued by their parents and subsidiaries and direct equity investors - in other words, it is debt that can be easily rolled over or cross-cancelled within the company accounts.

This week, Central Bank of Russia did the same when it produced new estimate for external debt maturing in September-December 2015. The CBR excluded “intra-group operations” and the new estimate is based on past debt-servicing trends and a survey of 30 largest companies.

As the result of revisions, CBR now estimates that external debt coming due for Russian banks and non-financial corporations will be around USD35 billion, down on previously estimated USD61 billion.

CBR also estimated cash and liquid foreign assets holdings of Russian banks and non-bank corporations at USD135 billion on top of USD20 billion current account surplus due (assuming oil at USD40 pb) and USD14 billion of CBR own funds available for forex repo lending.

Here are the most recent charts for Russian external debt maturity, excluding most recent update for corporate and banks debt:

As the above table shows, in 12 months through June 2015, Russian Total External Debt fell 24%, down USD176.6 billion - much of it due to devaluation of the ruble and repayments of maturing debt. Of this, Government debt is down USD22.1 billion or 39% - a huge drop. Banks managed to deleverage out of USD59.9 billion in 12 months through June 2015 (down 29%) and Other Sectors external liabilities were down USD88.8 billion (-20%).

These are absolutely massive figures indicating:
1) One of the underlying causes of the ongoing economic recession (contracting credit supply and debt repayments drag on investment and consumer credit);
2) Strengthening of corporate and banks' balance sheets; and
3) Overall longer term improvement in Russian debt exposures.

9/3/2014: Financial Repression, Debt Crises & Debt Restructuring: R&R Strike Again

According to Reinhart and Rogoff recent (December 2013) paper "Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten" (by Carmen M. Reinhart and Kenneth S. Rogoff, IMF Working Paper WP/13/266, December 2013 http://www.imf.org/external/pubs/ft/wp/2013/wp13266.pdf) many economies in the advanced world will require defaults, as well as drastic measures of Financial Repression, including savings taxes and higher inflation as debt levels reach a 200-year high.

You can read the entire paper, so I am just going to summarise some core points, albeit at length.


R&R open up with a statement that is more of a warning against our complacency than a claim of our arrogance: "Even after one of the most severe crises on record (in its fifth year as of 2012) in the advanced world, the received wisdom in policy circles clings to the notion that advanced, wealthy economies are completely different animals from their emerging market counterparts. Until 2007–08, the presumption was that they were not nearly as vulnerable to financial crises. When events disabused the world of that notion, the idea still persisted that if a financial crisis does occur, advanced countries are much better at managing the aftermath..."

This worldview is also not holding, according to R&R: "Even as the recovery consistently proved to be far weaker than most forecasters were expecting, policymakers continued to underestimate the depth and duration of the downturn."

The focal point of this delusional thinking is Europe, "…where the financial crisis transformed into sovereign debt crises in several countries, the current phase of the denial cycle is marked by an official policy approach predicated on the assumption that normal growth can be restored through a mix of austerity, forbearance, and growth."

The point is that European (and other advanced economies' policymakers are deceiving the public (and themselves), believing that they "…do not need to apply the standard toolkit used by emerging markets, including debt restructurings, higher inflation, capital controls, and significant financial repression. Advanced countries do not resort to such gimmicks, policymakers say. To do so would be to give up hard-earned credibility, thereby destabilizing expectations and throwing the economy into a vicious circle."

Note: per R&R "“Financial repression” includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and generally a tighter connection between government and banks. It often masks a subtle type of debt restructuring."

The warning that stems from the above is that "It is certainly true that policymakers need to manage public expectations. However, by consistently choosing instruments and calibrating responses based on overly optimistic medium-term scenarios, they risk ultimately losing credibility and destabilizing expectations rather than the reverse."

It is worth noting as a separate point in addition to the above issues that:

1. Financial repression in its traditional means (forcing public debt into investment portfolio of captive funds, such as pension funds, reducing real returns on savings, tax on savings, bail-ins of private investors etc) in the case of the advanced economies are running against demographic changes, such as ageing of these societies. Just as the economies reliance on savings and pensions rises, financial repression is cutting into the economies savings and pensions.
2. Higher inflation is associated with higher interest rates in the longer term, which can have a devastating impact on debt-burdened households. Hence, deleveraging of the sovereigns cuts against the objective of deleveraging the real economy (households and companies). This is most pronounced in the case of countries like Ireland.
3. Strong point from R&R on austerity. In many cases, advanced economies debate about austerity is 0:1 - either 'do austerity' or 'do expansionary fiscal policy'. This is superficial. Per R&R: "Although austerity in varying degrees is necessary, in many cases it is not sufficient to cope with the sheer magnitude of public and private debt overhangs."

So the key lessons from the past are as follows.

Lesson 1: "On prevention versus crisis management. We have done better at the latter than the former. It is doubtful that this will change as memories of the crisis fade and financial market participants and their regulators become complacent."

Figure 1. Varieties of Crises: World Aggregate, 1900–2010

A composite index of banking, currency, sovereign default, and inflation crises (BCDI), and stock market crashes (BCDI+stock) (weighted by their share of world income)


Lesson 2: "On diagnosing and understanding the scope and depth of the risks and magnitudes of the debt. What is public and what is private? Domestic and external debt are not created equal. And debt is usually MUCH bigger than what meets the eye."

R&R are not shying away from the bold statements (in my view - completely warranted): "The magnitude of the overall debt problem facing advanced economies today is difficult to overstate. The mix of an aging society, an expanding social welfare state, and stagnant population growth would be difficult in the best of circumstances. This burden has been significantly compounded by huge increases in government debt in the wake of the crisis, illustrated in Figure 2. …As the figure illustrates, the emerging markets actually deleveraged in the decade before the financial crisis, whereas advanced economies hit a peak not seen since the end of World War II. In fact, going back to 1800, the current level of central government debt in advanced economies is approaching a two-century high-water mark."

Figure 2. Gross Central Government Debt as a Percentage of GDP: Advanced and Emerging Market Economies, 1900–2011 (unweighted average)

Things are even worse when it comes to external debt, as Figure 3 illustrates.

Figure 3. Gross Total (Public plus Private) External Debt as a Percentage of GDP: 22 advanced and 25 Emerging Market Economies, 1970–2011

Note the 'exponential' trend on the chart above since the 1990s...

This is non-trivial (as per Figure 2 conclusions). "The distinction between external debt and domestic debt can be quite important. Domestic debt issued in domestic currency typically offers a far wider range of partial default options than does foreign currency–denominated external debt. Financial repression has already been mentioned; governments can stuff debt into local pension funds and insurance companies, forcing them through regulation to accept far lower rates of return than they might otherwise demand. But domestic debt can also be reduced through inflation."

And, as Figure 4 illustrates, public and external debts overhang are just the beginning of the troubles: "the explosion of private sector debt before the financial crisis. Unlike central government debt, for which the series are remarkably stationary over a two-century period, private sector debt shows a marked upward trend due to financial innovation and globalization, punctuated by volatility caused by periods of financial repression and financial liberalization."

Figure 4. Private Domestic Credit as a Percentage of GDP, 1950–2011 (22 Advanced and 28 Emerging Market Economies)

Lesson 3: "Crisis resolution. How different are advanced economies and emerging markets? Not as different as is widely believed."

R&R (2013) show "five ways to reduce large debt-to-GDP ratios (Box1). Most historical episodes have involved some combination of these."

As R&R note, "the first on the list is relatively rare and the rest are difficult and unpopular." But more ominously, "recent policy discussion has tended to forget options (3) and (5), arguing that advanced countries do not behave that way. In fact, option (5) was used extensively by advanced countries to deal with post–World War II debt (Reinhart and Sbrancia, 2011) and option (3) was common enough before World War II."

Beyond the fact that the two measures have precedent in modern history of the advanced economies, there is also the issue of the current crisis being of greater magnitude than previous ones.

"Given the magnitude of today’s debt and the likelihood of a sustained period of sub-par average growth, it is doubtful that fiscal austerity will be sufficient, even combined with financial repression. Rather, the size of the problem suggests that restructurings will be needed, particularly, for example, in the periphery of Europe, far beyond anything discussed in public to this point. Of course, mutualization of euro country debt effectively uses northern country taxpayer resources to bail out the periphery and reduces the need for restructuring. But the size of the overall problem is such that mutualization could potentially result in continuing slow growth or even recession in the core countries, magnifying their own already challenging sustainability problems for debt and old age benefit programs."


The authors conclude that "…if policymakers are fortunate, economic growth will provide a soft exit, reducing or eliminating the need for painful restructuring, repression, or inflation. But the evidence on debt overhangs is not heartening. Looking just at the public debt overhang, and not
taking into account old-age support programs, the picture is not encouraging. Reinhart, Reinhart, and Rogoff (2012) consider 26 episodes in which advanced country debt exceeded 90 percent of GDP, encompassing most or all of the episodes since World War II. (They tabulate the small number of cases in which the debt overhang lasted less than five years, but do not include these in their overhang calculations.) They find that debt overhang episodes averaged 1.2 percent lower growth than individual country averages for non-overhang periods. Moreover, the average duration of the overhang episodes is 23 years. Of course, there are many other factors that determine longer-term GDP growth, including especially the rate of productivity growth. But given that official public debt is only one piece of the larger debt overhang issue, it is clear that governments should be careful in their assumption that growth alone will be able to end the crisis. Instead, today’s advanced country governments may have to look increasingly to the approaches that have long been associated with emerging markets, and that advanced countries themselves once practiced not so long ago."


What R&R are showing in their paper is that Financial Repression already underway is hardly inconsistent with the potential for further restructuring and repression. They also show that the current crisis is still unresolved and ongoing and that the current de-acceleration in crisis dynamics is not necessarily a sign of sustained recovery: things are much longer term than 1-2 years of growth can correct for. In the mean time, as we know, the EU continues on the path of shifting more and more future crisis liabilities onto the shoulders of savers and investors, while offloading more and more public debt overhang costs onto the shoulders of taxpayers. All along, the media and our politicians keep talking down the risks of future bailouts, bail-ins and structural pain (lower growth rates, higher interest rates, higher rates of private insolvencies).


Note: You can read more on the rather lively debate about the effects of debt on growth by searching this blog for "Reinhart & Rogoff" Some of the links are here:

• 14/2/2014: Debt & Growth: New IMF Paper: http://trueeconomics.blogspot.ie/2014/02/1422014-debt-growth-new-imf-paper.html
• 31/12/2013: Debt and Growth: Consumption Crowding-Out Channel http://trueeconomics.blogspot.ie/2013/12/31122013-debt-and-growth-consumption.html
• 27/10/2013: Financial Repression, Economic Suppression & Budget 2014 http://trueeconomics.blogspot.ie/2013/10/27102013-financial-repression-economic.html
• 9/10/2013: Returning to Reinhart & Rogoff Debate http://trueeconomics.blogspot.ie/2013/10/9102013-returning-to-reinhart-rogoff.html
• 2/7/2013: Village June 2013: Real Effects of Government Debt Overhang? http://trueeconomics.blogspot.ie/2013/07/272013-village-june-2013-real-effects.html
• 17/6/2013: On Debt of the Nations & Euro Crisis: 2 links http://trueeconomics.blogspot.ie/2013/06/1762013-on-debt-of-nations-euro-crisis.html
• 10/10/2012: Irish Real Economic Debt - Busting Records http://trueeconomics.blogspot.ie/2012/10/10102012-irish-real-economic-debt.html
• 26/09/2011: Ireland's Debt Overhang - unprecedented, unmanageable & unsustainable http://trueeconomics.blogspot.ie/2011/09/26092011-irelands-debt-overhang.html

24/11/2014: External Debt Maturity Profile: Russia H1 2015-H1 2016

I covered recently Russian capital outflows data (see here: http://trueeconomics.blogspot.ru/2014/11/23112014-russian-economy-capital.html). 

Now, lets take a look at the data for External Debt maturity profile for the economy. The reason for why this is of importance is that currently Russian enterprises and banks (even those not covered by the sanctions) have effectively no access to dollar and euro funding in international markets, making it virtually impossible for them to roll maturing debts. 

Chart below shows the quantum of debt maturing over the 18 months between January 2015 and through June 2016. The total amount of maturing external debt to be funded by Russian state, banks and enterprises is USD138.796 billion. 

Of this, just USD4.03 billion is Government debt (or just 2.9% of the total maturing debt). Which pretty much means there is no public debt sustainability issue in sight as the result of the sanctions no matter what debt ratings are issued to the sovereign.

A third of total external debt coming due in H1 2015 through H1 2016 is banks debt (33.6% of the total) amounting to USD46.627 billion. There is a steep curve on banks funding requirements in H1 2015 at USD20.646 billion, scaling down to USD15.19 billion in H2 2015 and to USD10.791 billion in H1 2016. All of these relate to either loans or maturing deposits, with zero exposure to debt securities. Much of it is, therefore, down to interbank lending markets.

Almost two thirds of external debt coming due over the next 18 months is Non-financial Corporate loans (USD65.311 billion or 63.5% of the total). This excludes debt liabilities to direct investors which add additional USD21.245 billion to the above total for the sector and the above total maturing debt. However, as it is written against the equity holders, these debts can be restructured separately from the direct and intermediated debts. Again, H1 2015 represents the highest burden on debt rollover/repayment with USD25.41 billion of loans maturing. This declines to USD21.1 billion in H2 2015 and to USD18.8 billion in H1 2016.

Chart below summarises:

So to summarise, Russia is facing steep repayment schedule on non-Governmental debt in H1 2015, declining in H2 2015, with even more benign demand in H1 2016.  While Russian Central Bank has funds to cover the above volumes of redemptions, even allowing for adjustments to the funds for liquidity risk, the quantum of debt maturing in the next 18 months is high and will require some significant strain on cash flows of the enterprises and possibly significant injections of funding from the state.

The obvious question is: how much equity will migrate from private ownership to state ownership in the latter case.

28/10/15: Russian Economy Update: Consumption and Debt

Updating Russian stats: September consumption and deleveraging: bigger clouds, brighter silver lining. 

In basic terms, as reported by BOFIT, per Rosstat, Russian seasonally-adjusted retail sales (by volume) fell more than 10% y/y in September, with non-food sales driving the figure deeper into the red. On the ‘upside’, services sales to households fell less than overall retail sales. This accelerates the rate of decline in household consumption expenditure - over 1H 2015, expenditure fell just under 9% y/y. Small silver lining to this cloud is that household debt continued to decline as Russian households withdrew from the credit markets and focused on increased savings (most likely precautionary savings).

Russian households are not the only ones that are saving. Overall external debt of the Russian Federation fell, again, in 3Q 2015, with preliminary data from the Central Bank of Russia figures putting total foreign debt at USD522bn as of end-September, down just over USD30bn compared to 2Q 2015. Per official estimates, ca 50 percent of the overall reduction q/q in external debt came from repayment of credit due, while the other 50 percent was down to devaluation of the ruble (ca 20 percent of Russian external debt was issued in Rubles).

Overall, 3Q 2015 saw some USD40 billion of external debt maturing, which means that over 1/4 of that debt was rolled over by the non-bank corporations. Per CBR estimates, ca 40% of the external debt owed by the Russian non-bank corporations relates to intragroup loans - basically debt owed across subsidiaries of the same percent entity. And over recent quarters, this type of debt has been increasing as the proportion of total debt, most likely reflecting two sub-trends:
1) increasing refinancing of inter-group loans using intra-group funds; and
2) increasing conversion of intra-group investments/equity into intragroup debt (and/or some conversion of FDI equity into intra-group debt).

Over the next 12 months (from the start of 4Q 2015), Russian foreign debt maturity profile covers USD87 billion in maturing obligations against country currency reserves of USD370 billion-odd. As noted by BOFIT, “A common rule-of-thumb suggests that a country’s reserves need to be sufficient to cover at least 100% of its short-term foreign debt to avoid liquidity problems.” Russia’s current cover is closer to 430%. And that is absent further ruble devaluations.

A chart via BOFIT:

27/4/17: Russian Economy Update, Part 2: Two Key Sectors

Two key sectors to watch

Now, looking at some sectors across the Russian economy

Manufacturing:

• In 2015, total volume of manufacturing output dropped 5.4% and in 2016 it was basically unchanged on foot of robust growth in the chemical sector (+5.6% growth) and food sector (ca 2% growth)
• Other positive growth sectors were Pulp & Paper and Rubber & plastics, Wood products and Machinery and Equipment. The latter sector has been in a free-fall since 2012
• Negative growth continued in Transport vehicles (negative growth since 2014), Metals and products (also in decline since 2014)
• Production of oil products fell, ending years of growth starting even before 2007
• Construction materials experienced their second year of declining output
• Electrical machinery & equipment continued to contract for the fourth year in a row

• Corporate Leverage:
• Overall, economy continued to deleverage out of debt, especially external debt. CBR data shows that by the end of 2016, private sector external debt stood at USD470 billion, of which more than ¾ was held by non-financial corporates and ¼ held by the banks.
• The external debt/GDP ratio was stable and benign at 36%
• Corporate debt is largely - 80% - non-ruble denominated, while the same number for the banks was around 87%
• Corporate deleveraging slowed down substantially in 2016 as debt rollovers fell and debt renegotiations/restructurings declined
• Changes in ruble valuations had positive effect on debt burden in the oil and gas sector (forex earnings) and negative effect on debt burden in domestic producers
• If in 2014-2015, companies used receipts of funds from parent holding enterprises to roll over maturing debt, in 2016 these funds were increasingly used to pay down debt. In effect this means that the first part of the deleveraging cycle has swapped external debt for internal debt, while current phase of the cycle is witnessing overall debt levels reductions.

Banking sector:

• In contrast to 2014-2015, the ruble valuations acted largely to reduce debt burdens in the banks, as ruble appreciation in 2016 supported the forex valuation of the foreign debt 
• Banks deleveraging continued in 2016, at a pace that is roughly ½ the rate of 2015 and 2014 
• Data from the CBR show total banking sector assets fell last year by 3.5% in nominal terms
• Controlling for FX effects (ruble appreciation), total assets were up ca 2% at the end of 2016, compared to the end of 2015
• Stock of loans outstanding to the corporate sector was down roughly 4%, while stock of loans to households rose by more than 1%
• However, overall household credit contracted 7% in 2015, making 2016 recovery weak 
• Non-performing loans (NPLs) are declining as a share of the assets base, with decline accelerating in recent months
• NPL ratio for corporate loans still exceeded 6%
• Household credit NPL ratio was about 8%
• Aggregate banking sector 2016 profits rose five-fold to $15 billion y/y
• Three large SOE banks (Sberbank, VTB and Gazprombank) accounted for over half of the banking sector profits
• The CBR has continued to weed-out poorly run and non-performing banks using tools ranging from full shut down to forced mergers 
• At the start of 2017 there were 623 active credit institutions in Russia, of which 205 institutions had general banking licenses
• At the same time in 2016 there were 733 active credit institutions

Economics 03/05/2010: World Debt Wish 4

This is the fourth post in the series covering world debt issues. In the previous post I provided analysis of the aggregate debt levels for 36 largest debtor nations (here) and for the Government debt (here) and the banks debt (here). The current post looks at the country-level data.
Chart above plots the evolution of the Gross External Debt for top 10 debtor nations. The US, predictably leads the way. Remember - these are absolute debt volumes, not relative to GDP. UK comes in second. While the UK Gross External Debt has actually declined in the duration of the crisis, that of the US remained on the rising path, with current GED levels in the US above the 2007 bubble peak. The same is true of the third (France) and fourth (Germany) countries.

Ireland is a remarkable member of this list, coming in ranked 8th largest debtor nation overall in the world in Q4 2009 - up from the 10th in Q4 2003. This clearly shows that in the Irish case, the debt bubble has been forming in the economy well before 2003. My previous research suggests that Irish debt bubble has started forming back in 1998-1999, the last year when our current account registered positive balance, as chart below illustrates:
What's even more interesting is that in 2009 Ireland held 4.1% of the total debt of the 36 most indebted countries, while producing less that 0.37% of the same group of countries' combined GDP. This implies that our economy's dependence on debt is 11 times greater than that of the group of 36 most indebted nations. Put into household finances perspective, we have managed to borrow ourselves into a complete corner, whereby our indebtedness is systemically important to the world, while our economic existence is not. If not for the euro, folks, we would have bailiffs from the IMF calling in.

Having borrowed more than Japan and Belgium, we are also leagues ahead of other, much larger economies in terms of GED:
Think of it: Irish debt is

• x2 times greater than Australia,
  
• x2.5 than Canada,
  
• x3 Hong Kong & Denmark,
  
• x5 Greece
  
• x2 the combined debt of Brazil, India & Russia which have combined 2009 GDP more than x44 times that of Ireland!

And we are the 'rich country' that is contributing to international aid and relief for the HIPCs (Highly Indebted Poor Countries) and whose Presidents (current and former) are jet-setting around the world dispersing piles of taxpayers' cash in aid and preaching economic reforms. Comical or farcical, folks?

Couple of scatter plots showing Q4 2003 position against Q4 2009 one:
Predictably, the US and UK are outliers, so let's zoom on the data ex-US & UK:
Majority of the 36 countries which are world's largest debtors locate above the 1-1 line, implying that between 2003 and 2009 total debt levels have risen in these countries. Countries that are above the regression line have above-average propensity to increase indebtedness between 2003 and 2009. Ireland sticks out like a sore thumb - sporting the largest Gross External Debt increase of all comparators, relative to the starting position in Q4 2003. The overall relationship between the starting debt levels and the current ones is extremely strong - something to the tune of 98% of variation in current debt positions is explained by the starting ones, which simply means that all 36 countries are habitual addicts to debt. Again, Ireland is the leading addict in the club.

A caveat, of course is due here - the figures for Ireland do include IFSC, but hey, why shouldn't they - IFSC is our economic miracle, isn't it? It provides jobs in Ireland. It pays taxes in Ireland. It pays rents to Irish developers...

Of course, do recall that GED includes 3 sectors in it - Banks, Government and the rest of the economy. Banks and Government, as I've shown in the previous post, are linked:
But the link is not particularly strong: correlation between GGD & Banks Debt was +0.49 in 2003 - positive, but not exceptional. It rose to +0.55 in 2009, reflecting the crisis measures transferring taxpayers wealth to the banks. But this too is not dramatic. A relatively modest increase in correlation between 2003 and 2009, plus the fact that we already had a positive correlation back in 2003 highlight pro-cyclicality of fiscal policies worldwide.

Now, let's put the GEDs together, for comparatives:
Ireland is the member of USD1 trillion debt club, despite having a substantially smaller income than any of the countries around it. Even removing IFSC out of this equation still leaves us in the club, pushing our total debt to the 12th position worldwide.

In the next post, I will look at the debt levels relative to countries' GDP, so stay tuned.

Economics 11/03/2010: Debt figures confusion reigns at RTE?

Per RTE report yesterday (emphasis is mine, see original here)

“New figures from the Central Bank show that at the end of January Irish residents - mostly companies and institutions - had an outstanding debt of €1.1 trillion. Figures for issued debt securities indicate that €790 billion worth of this debt is denominated in euro, while the remaining €270 billion is denominated in foreign currencies."

This, indeed, is misleading enough for the non-economist. While RTE choice of words ‘outstanding debt’ might imply ‘total debt’, in reality, of course, the Central Bank note (available here) is dealing only with securitized debt: bonds, notes and debt securities issued, plus equity issued. But it does not include non-securitized loans, mortgages, corporate loans, over drafts, credit cards, corporate invoice-discounting, and even massive volumes of investment fund shares/units.

This, if course, explains how the figures issued today differ from our real total debt measure: the Gross External Debt of all resident sectors, published quarterly (with one quarter delay) by CSO. Q4 2009 is still due for release later this month, but per latest CSO data, in Q3 2009, the gross external debt of all resident sectors in Ireland stood at €1,637bn or €51bn down on the Q2 2009 level – some €537 billion more than what RTE’s note mistakenly labelled to be Ireland’s outstanding debt.

The liabilities of Ireland-based monetary financial institutions (aka our financial system inclusive of IFSC) were virtually unchanged quarter on quarter at €691bn with their share of total debt rising from 41% in Q2 2009 to 42% in Q3.

Similar dynamic took place in Other Sectors – comprising insurance companies and other financial enterprises, plus non-financial companies – where debt as of Q3 2009 stood at €618 billion or 38% of the total, up from 37% in Q2 2009.

Virtually all of the quarterly decrease in our indebtedness came from the Central Bank funds changes. This is why excluding the Central Bank and Government liabilities, total economy debt rose from €1.513 trillion in Q2 2009 to €1.508 trillion in Q3 2009.

Since Q3 2007, the overall debt levels in Other Sectors rose by a cumulative of 15.6%, in Direct Investment sector by 9.3%, and our total debt rose by 8.33%. At the same time, our wealth - or assets side - have collapsed by over 60%.

Only banks have so far managed to de-leverage in Ireland (down 9.8% on Q3 2007) thanks to the taxpayers’s cash. Which brings us to a sad but inevitable conclusion – while banks use our money to write down their bad debts, is it any surprise that the real debt burden in the Irish economy is not declining?

Now, paired with Central Bank information note, if we subtract from the total debt figure in Q3 2009 the approximate IFSC-related debt of €850-900 billion (reflecting both securitized and non-securitized debt held, keeping in mind that most of the IFSC debt is securitized), this leaves Irish resident companies, households, banks, financial services providers and the public sector in the hole for roughly €730-790 billion.

Take this into a perspective: this number is equivalent to

• €165,273-176,485 debt per every man, woman and child in this country – resident and citizen (per latest CSO population data, here)
• Assuming paydown in the amount of our annual public deficit projected for 2010, this debt mountain will take us 41-44 years to pay down without any interest accruing on it (just think of 44 years of austerity and you get the picture)
• At the current interest rate charged on Government borrowing, the annual interest bill relating to our economy’s debt mountain adds up to €36.85-39.35 billion or more than 50% of the total annual Exchequer expenditure (just a reminder, we are being offered a plan to borrow more by the Letter of 28 - here - because, apparently, we have not borrowed yet enough)
  
• Given the average family size in Ireland (2.82 persons per household) and the latest average house price (€242,000 per Q4 2009 daft.ie report), this level of indebtedness is equivalent to 2 houses per every family in the Republic

Shall I go on? Sadly, reading RTE report one might conclude that things are ok: most of our outstanding debt is owed by the IFSC, so no need to worry, folks. Alas, that would be as wrong as calling today’s data release from the Central Bank a true reflection of our debt mountain.

18/4/15: Fitch Postpones Russian Ratings Review on Improved Data

As noted yesterday, both Fitch and S&P came out with (well, sort of came out in Fitch case) updated ratings for Russia. I covered S&P ratings here: http://trueeconomics.blogspot.ie/2015/04/17415-conservative-to-surprising-degree.html

Now onto Fitch.

According to the Russian Finance Minister, Anton Siluanov, Fitch postponed formal ratings review and held Russian ratings at BBB- - just a notch above junk grade. Fitch, thus, retains the only non-junk rating for Russia amongst the Big 3 agencies, with S&P at BB+ and Moody's at Ba1. According to Siluanov, the postponement reflects improved data outlook for the Russian economy.

Fitch was the first of the Big 3 to cut Russia’s rating back on January 9 (see http://www.reuters.com/article/2015/01/09/fitch-downgrades-russia-to-bbb-outlook-n-idUSFit89012120150109). Since then, Russian eurobond issue, maturing 2030 posted a 13 percent plus rise. In part, this reflects firming up of the ruble, and to a larger extent - the unprecedented levels of liquidity flowing into sovereign bonds markets worldwide. But in part, improved yields are also reflective of adjusting expectations concerning Russian economy. For example, alongside their February downgrade, Moody's estimated Russian capital outflows for 205-2016 at USD400 billion and Russian GDP was forecast to fall by 8.5%. Current consensus in the markets is that outflows will be closer to USD150-170 billion (on expected debt maturities) and the economy is likely to contract by closer to 4-4.5%.

Capital outflows figures stabilisation has been rather significant, especially given the level of debt redemptions in 1Q 2015 (see here: http://trueeconomics.blogspot.ie/2015/04/14415-russian-external-debt-redemptions.html). In 1Q 2015, estimated outflows totalled just USD32.6 billion, compared to USD77.4 billion in 4Q 2014 and with USD48 billion outflows in 1Q 2014. While banks continued to deleverage, non-financial sector was able to roll over much of maturing debt and were repatriating assets into Russia. The net result was inflow of forex into the Ruble market.

Deleveraging in the Russian economy is going at a breakneck pace: in mid-2014 Russian external debt (over 90% accounted for by private sector) stood at just over USD730 billion. By the end of 1Q 2015 estimated external debt has fallen to USD560 billion, implying net debt reductions of USD170 billion over the span of 9 months, well above my earlier estimate of net repayment of USD96.5 billion that excluded Ruble devaluation effects. The USD170 billion estimate includes devaluation of the Ruble and roll-overs when these involved conversion from forex-denominated inter-company loans and equity into Ruble-denominated ones. It is worth remembering that roughly 1/4 of Russian external debt is denominated in Rubles.

When it comes to sovereign ratings, it is also worth remembering that Russian public sector external liabilities amount to less than 10 percent of the total external debt.

Overall, Fitch decision to hold Russian ratings under review is a reflection of the recent improvements in the economic outlook, but also the fragile and early nature of these. As I noted on numerous occasions before, the situation is fragile and the risks to the downside are prominent, so Fitch's more cautious approach to ratings is probably better justified by the current environment.

5/1/2015: IMF on Debt Relief for Greece: Repeating the Repeats

Much of talk nowadays from the European leaders on Greek debt situation and the link to political crisis in the country. Some conversations are about lack of potential contagion from Grexit, other conversations are about the right of the Greeks to decide on their next Government, whilst all conversations contain references to the new Government having to abide by the previous commitments. Which is fine. Except, what about the European partners commitments? Specifically one commitment - relating to further debt relief for the country?

Here is 2013 IMF assessment of the Greek situation (emphasis in italics is mine):

"47. The program continues to satisfy the substantive criteria for exceptional access but with little to no margin. Delays in the implementation of structural reforms raise concerns about the capacity of the authorities to implement the program in a difficult political environment. …The continued commitment of euro area member states to support Greece, including by providing additional official financing to fill future financing gaps and through further debt relief as necessary, is an essential part of meeting the criteria."

And then:

"48. …The program is fully financed through July 2014, but a projected financing gap will open up in August 2014. Thus, under staff’s current projections, additional financing will need to be identified by the time of the fifth review, to keep the program fully financed on a 12-month forward basis. The Eurogroup has initiated discussions on how to eliminate the projected financing gaps. In this regard, the Eurogroup’s commitment in February and November 2012 to provide adequate support to Greece during the life of the program and beyond, provided that Greece fully complies with the program, is particularly important."

For some more on debt relief:

"55. As noted in the third review staff report, debt sustainability concerns continue to remain a risk. …The commitment of Greece’s European partners to provide debt relief as needed to keep debt on the programmed path remains, therefore, a critical part of the program. But the programmed path entails still very high debt well into the next decade, leaving Greece accident prone for an extended period. Should debt sustainability concerns prove to be weighing on investor sentiments even with the framework for debt relief now in place, European partners should consider providing relief that would entail a faster reduction in debt than currently programmed."

And

"56. …The program remains subject to numerous risks, mainly from the worsening of the macro outlook combined with a further deterioration in banking sector assets (feeding back to the real economy), difficulties with the implementation of ambitious fiscal policy and administrative changes, and—above all—failure once again to ensure a reinvigoration of structural reforms in the face of strong resistance from vested interests. Absent a critical mass of structural reforms that would transform the investment climate, the growth outlook—and, therefore, crucially the assumptions regarding financing needs for the rest of the program period and the debt path—would not materialize. Externally, closing financing gaps and delivering on the commitment to reduce debt will be a test of European support."

And in Box 4, Criterion 2:
" …In light of the commitments from euro area member states to provide additional debt relief as necessary, the baseline debt trajectory is sustainable in the medium-term but subject to significant risks."

Link to the above: http://www.imf.org/external/pubs/ft/scr/2013/cr13241.pdf


But there are more statements from the IMF on the issue of debt relief for Greece.

Take for example Transcript of a Press Briefing by William Murray, Deputy Spokesman, International Monetary Fund, from September 11, 2014 (http://www.imf.org/external/np/tr/2014/tr091114.htm):

"QUESTIONER: You told us many times from this podium that the issue of the Greek debt will be discussed at the sixth review. As I understand this, it's going to begin at the end of the month. The Euro Group said on Monday that the debate will begin after the sixth review. What we want to hear is that are the discussions about the financing of the Greek program and about the debt, still proceeding on an orderly way as you told us before many times? And what is your plan or your strategy for the Greek debt? Is there an option of those talks between you and the Europeans? Are the Europeans onboard to discuss this big problem for Greece?

MR. MURRAY: ...I do want to remind you and others what we have said all along. There is an agreed framework in place for ensuring debt sustainability with Greece's European partners agreeing to provide any additional debt relief as needed to help bring Greece's debt down to 124 percent of GDP by 2020. And to substantially below 110 percent of GDP by 2022 as long as Greece continues to deliver on its program commitments."

Now, IMF estimates debt/GDP ratio for Greece to be at 170% of GDP. Which means that over the next 5 years, the programme will have to deliver debt.GDP ratio reduction of a massive 50 percentage points. How on earth can this be achieved without debt relief is anyone's guess.

And more: Interview by Greece’s newspaper Ethnos with IMF Mission Chief for Greece, Poul Thomsen, published in Ethnos, June 15, 2014 (http://www.imf.org/external/np/vc/2014/061514.htm):

"QUESTION: You talk constantly about the commitment of Europeans regarding the financing needs of Greece and Greek debt relief. If Europeans do not show the determination needed or the courage to take bold decisions, like last time, what is the IMF planning to do?

ANSWER: We are confident that the European partners will deliver on their commitments. Do you believe that Greece's debt is now sustainable or do you believe that the situation needs new and drastic interventions? Are European commitments to contribute to debt relief enough for the IMF? What could the potential tools for debt relief be? The agreed framework is credible, provided that Greece and its European partners deliver on their promises. For Greece, this means continuing to advance reforms and achieving and maintaining a fiscal primary surplus of 4.5 percent of GDP. For the European partners, this means providing additional debt relief, if required, to keep debt on the programmed path. Thus, if adhered to, the framework will make the debt sustainable."

So 4.5% primary surplus over 5 years - even if achieved, will deliver somewhere in the neighbourhood of 1/2 of the required debt adjustment. The rest, presumably, will have to be achieved via economic growth, which will have to be running, on average, at 4% per annum to provide for the adjustment planned. And, thus, do tell me if the above any realistic, let alone probabilistically plausible.

In its 5th (most recent) assessment of the Greek situation, IMF reiterated (paragraph 49) that "The continued commitment of euro area member states to support Greece, including by providing additional official financing to fill future financing and through further debt relief as necessary, is an essential part of meeting the criteria" for debt sustainability. (see http://www.imf.org/external/pubs/ft/scr/2014/cr14151.pdf)

And it also carries Greek authorities expectation of the European funders agreement to further debt relief: "The program is fully financed through the next twelve months. Firm commitments are also in place thereafter from our euro area partners to provide adequate support during the program period and beyond, provided that we comply fully with the requirements and objectives of the program. In this regard, we remain on track to receive the first phase of conditional debt relief from our European partners, as described in the Eurogroup statements of November 27 and December 13, 2012." (page 71)

The same was stated in May 2014 Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding from the Greek authorities (see: http://www.imf.org/external/np/loi/2014/grc/051414.pdf). On foot of the IMF press conference statement on same (see: http://www.imf.org/external/np/tr/2014/tr050814.htm).

And so on, to no end and… no closure from the European partners…

Economics 01/10/2009: External Debt - still a problem

As of 30 June 2009, per CSO’s today release, “the gross external debt of all resident sectors (i.e. general government, the monetary authority, financial and non-financial corporations and households) amounted to almost €1,689bn. This represents a drop of €7bn or 0.4% …compared to the level shown (€1,696bn) at the end of March 2009.”

“…the bulk of Ireland’s external debt arises from the liabilities of IFSC financial enterprises and also that most of its overall foreign financial liabilities are offset by Irish residents’ (including IFSC) holdings of foreign financial assets.” Hmmm… again this over-emphasis of IFSC. One note of caution - we do not actually know if these 'assets' are valued at fair rates (we do not know what percentage of these assets is valued at mark-to-market, and what percentage is valued at hold-to-maturity bases), so some questions to the quality of the assets can be raised.

“Liabilities of monetary financial institutions (credit institutions and money market funds) consisting mostly of loans and debt securities were almost €691bn, a drop of almost €27bn on the 31stMarch 2009 stock level and down €117bn on the June 2008 level.” In other words, our banks are de-leveraging… as in charts below… but at whose expense?

The reduced liabilities of MFIs “are broadly reflected in the significantly increased Monetary Authority liabilities of €103bn, up by over €98bn since June 2008. These obligations are to the European System of Central Banks (ESCB)...” Aha, de-leveraging by loading up on those ECB loans, then?

But wait, there is more: “The liabilities of other sectors including those of insurance companies and pension funds, treasury companies and other relevant financial enterprises, as well as non-financial enterprises were €624bn, remaining relatively flat compared to end-March 2009. However, compared to end-June 2008, these liabilities had increased by €28bn.” Yeeeeks – banks de-leveraging is pushing ‘other sectors’ – aka the real economy – deeper into debt.

But wait, there is more: “The level of general government foreign borrowing increased by €10bn to €72bn between March and June this year and was €29bn up on the June 2008 level.” Ooops, banks are costing us here too (as do our social welfare rates and public sector wages bills).
Pull one end of the cart up, the other end sinks?

Some details on top of CSO’s release:
Table above shows percentage increases in debt levels across sectors and maturities. Pretty self-explanatory. The Exchequer is borrowing short and increasingly so. But the Exchequer is borrowing long as well, and rather aggressively as well. Monetary Authority is truly remarkable. Incidentally, MA borrowings are mostly short-term (higher than 3:1 ratio to long-term).

Banks (oh, sorry, MFIs) are cutting back debt more aggressively this year than in 2008. And, strangely enough, they are cutting more long-term debts than short-term debts (in proportional terms). Of course, this in part reflects bad loans provisions and pay downs of Irish subsidiaries debt by foreign parents.

Other sectors are rolling up accumulated interest and amassing new loans. Short-term liabilities net of trade credits are up over two years, trade credits flat over last year. What does it tell you about importing activities?
Shares of MFIs in total debt thus are falling across the years, as are FDI shares, but everything else is rising.

Looking at short vs longer term debt issuance by sector:
Monetary Authority is now almost all short-term, Government is increasingly short-termist as well. Maturity mismatch risk is rising as is, but with Nama (a rolling 6-months re-priced bond against 10-20 years work out window on loans) maturity mismatch risk on Government balance sheet will go through the roof.
MFIs short term debt is now also declining, while long term debt has been declining for some time. It would be interesting to have this broken down by foreign vs domestic lenders, but there is no such detail in CSO figures, despite CSO's constant repeating that the figures include IFSC. If IFSC is so important to this analysis - why not report it separately?

Other sectors are relatively flat, which is bad news. Trade credits flat as well.

Overall, lack of significant de-leveraging and in some cases, continued accumulation of liabilities, in the real economy.

20/7/15: Of 'Break-Even' Oil Prices & Russia

An interesting chart via Deutsche Bank Research putting break-even (fiscal budget) figures on oil prices for major oil producers:

Which puts Russian break-even at USD105 pbl.

Reality is: Russia has capacity to increase oil output further and has done so already (note that it is now world's largest oil producer). It can also raise some other exports volumes, though general global conditions are not exactly supportive of this. Which underpins revenue side of the budgetary balance somewhat.

Meanwhile, Russian Government own budgetary estimates put break-even price of crude at around USD80-85 pbl, not USD105 pbl, closer to UAE, than to Oman.

Worse, for Deutsche, Russian budget is expressed in rubles, not USD, which means that FX valuation of the Ruble to a basket of currencies (Russian exports are not all priced in USD) co-determines the break-even price. Moderating (albeit still very high) inflation and EUR trend, compared to USD trend, suggest falling 'fiscal break-even' price of oil for Russia.

There are too many variables to attempt to estimate effective and accurate 'break-even' price for oil for Russia.

What is, however, clear is that Russian current account (external balance) is in black and it is improving, not deteriorating. Latest Balance of Payments data shows current account surplus of almost USD20 billion in 2Q 2015. Over 12 months through June 2015, current account surplus is at 4% of GDP. The driver here: decline in imports (down 40% in dollar terms in 2Q 2015 y/y) outpacing drop in exports (down just under 30% y/y). In January-June 2015, trade surplus was USD70 billion (USD210 billion in exports, USD140 billion in imports).

Balance of payments is also being supported to the upside by a decline in capital outflows. 2Q 2015 capital outflows amounted to ca USD20 billion, predominantly comprising banks repayment of maturing foreign debt (remember, this improves banks' balancesheets and deleverages the economy). However, direct investment from abroad into Russian non-fianncial corporations rose over the 2Q 2015, resulting in an increase in foreign debt held by the non-financial sector.

Overall, Russian Central Bank shows foreign debt position at ca USD560 billion (or 30% of GDP) at the end of 2Q 2015 - basically unchanged on 1Q 2015 and down from USD730 billion at the end of 2Q 2014.

And another reminder to fiscalistas:

• Russian public (Government) external debt currently stands at USD35 billion. 
• State-controlled banks hold further USD90 billion in external debt (total banking sector external debt is USD150 billion and 60% of that is held by state-owned banks).
• State-controlled NFCs firms hold ca 40% of USD360 billion foreign debt written against Russian NFCs, or USD144 billion. 
• Accounting for cross-holdings and direct equity-linked debt, net foreign debt that has to be repaid at maturity or refinanced by NFCs and Banks owned by the Russian Government is probably around USD150-160 billion. 

Sizeable, but less than 12% of GDP even after including the official public debt and state-owned enterprises debts.

Daily Economics 31/03/2009

Irish external debt stats for Q4 2008 are out and, guess what, things are looking worse than before. Here is the CSO table:
Now, the Gross External Debt itself is up for the year as a whole: from €1.579 trillion (yes, trillion) in Q1 2008 to €1.661 trillion in Q4 2008. But look closer to the details (see chart below for illustration):

• Gen Government Debt is obviously up - we are borrowing sh***t loads of money. But, GG short-term liabilities are also taking off, which confirms my argument: we are increasingly borrowing short, frontloading future deficits. This is before we factor in the Q1 2009 seriously aggressive short-term debt raising.
  
• Monetary authorities debt is going ballistic - all of this is in short term liabilities.
• Monetary financial institutions (financial sector etc) is declining overall, but slowly, and the short-term debt is rising - gain, trouble ahead refinancing this 'oxygen'.
• Other sectors - the real economy - debt is up and short-term liabilities are also up.
  

So, despite CSO's brave claims - the title of today's note is Ireland’s External Debt decreases to €1.66 trillion at end December - in reality, the debt mountain is still growing (in yearly comparisons) and the nasty short-term debt overloads are getting heavier.

Now, think, what will happen if the Government was successful in restarting banks lending?

Per one of the readers comments, here is the table with actual nominal increases in various debt headlines.

26/1/2012: IMF's latest statement on Greece

Here's an interesting statement:

Given widespread press speculation and rumors regarding IMF views, the following can be attributed to an IMF spokesman, William Murray:

"To ensure debt sustainability for Greece, it is essential that a new program be supported by a combination of private sector involvement and official sector support that will bring debt to 120 percent of GDP by 2020. The Fund has no view on the relative contribution of private sector involvement and official sector support in achieving this target. In line with this view, the IMF has not asked the ECB to play any specific role."

So IMF is making a pre-emptive announcement of 'neutrality' on the issue of the day - who'll be blamed when Greek PSI talks eventually end up in the courts and Greek debt/GDP ratio shoots past 150% mark.

And here's IMF own December 2011 report on Greece (available here)"

Page 13:
"The previous July 21 financing package [agreed for Greece] would not work. Public debt would peak at 187 percent of GDP in 2013 and fall to 152 percent of GDP by 2020. Net external debt would peak at 128 percent of GDP in 2012 and fall to 96 percent of GDP by 2020. These already weak downward trajectories would not be robust to shocks.

The precise outcome of the PSI exercise has an important bearing on public debt dynamics and how robust any improvement would be (the external debt sustainability analysis shows a similar pattern):

• With near-universal participation in a debt exchange targeting a 50 percent face value haircut and offering a low coupon, and European support at an interest rate of about 4 percent, debt could be brought to 120 percent of GDP by 2020 (the maximum level considered sustainable for a market access country). The trajectory would also be less susceptible to shocks (including to the official sector funding cost), although a longer period of time would be required to bring debt-to-GDP below 120.
• However, with low participation in the debt exchange and a significant amount of hold outs to be amortized with European support—a real risk under a purely voluntary approach (i.e., an approach not involving any measures to induce higher participation levels)—debt could stick above 145 percent of GDP in 2020. Moreover, the trajectory would no longer be robust to the usual range of shocks.  

Thus, securing a sustainable debt position will depend on whether PSI negotiations deliver the targeted €100 billion in debt reduction, in particular on the ability of the features of the exchange to deliver near-universal participation."

So in other words, why issue pre-emptive statements now? Because a month ago IMF has already washed its hands on Greece, basically saying that, 'look, if all goes really well, things might get to sustainable scenario (assuming Greece delivers on all structural reforms and privatizations and there are no slippages in growth and external balances, etc), but we don;t quite believe they will...'

Economics 12/04/2010: The next incoming train has left its first station

My current article on the longer term prospects for global economy, published in the current issue of Business & Finance magazine. This is an unedited version.

Forget the circus of the Euro zone Government’s bickering about Greece’s bailout package and the escapist idea of setting up the EU-own EMF. The real crisis in the Euroland is now quietly unfolding behind he scenes.

Finally, after nearly 15 years of denial, courtesy of the severe pain inflicted by the bonds markets, Brussels and the core member states are forced to face the music of their own making. The current crisis affecting Euro area economy is, in the end, the outcome of a severely unbalanced economic development model that rests on the assumption that exports-led economic expansions in some countries can be financed through a continued massive build up in financial liabilities by their importing partners.

Put more simply, the problem for the world going forward is that in order to sustain this economic Ponzi game, net importers must continue to finance their purchases of goods and services from net exporters by issuing new debt. The debt that eventually settles in the accounts of the net exporters.

One does not have to be versed in the fine arts of macroeconomics to see that something is wrong with this picture. And one does not have to be a forecasting genius to understand that after some 40 years of rising debts on the balance sheet of importing nations, the game is finally up. I wrote for years about the sick nature of the EU economy - aggregate and individual countries alike.

Last week, Lombard Street Research's Charles Dumas offered yet another clear x-ray of of the problem.


Source: Lombard Street Research, March 2010

As Dumas' chart shows, core Euro area economies are sick. More importantly, this sickness is structural. With exception of the bubble-driven catch-up kids, like Spain, Ireland and Greece, the Euro area has managed to miss the growth boat since the beginning of the last expansion cycle.

The three global leaders in exports-led growth: Germany, Japan and Italy have been stuck in a quagmire of excessive savings and static growth. Forget about jobs creation – were these economies populations expanding, not shrinking, the last 10 years would have seen the overall wealth of these nations sinking in per capita terms. Only the Malthusian dream of childless households can allow these export engines of the world to stay afloat. And even then, the demographic decline will have to be sustained through disposal of accumulated national assets. So much for the great hope of the exports-led growth pulling us out of a recession. It couldn’t even get us through the last expansion!

Over the last decade, the Sick Man of Europe, Italy has managed to post no growth at all, crushed, as Dumas’ put it, by the weight of the overvalued and mismanaged common currency. The Sick Man of the World, Japan has managed to expand by less than 0.8% annually despite running up massive trade surpluses. Germany’s ‘pathetic advance over eight years’ adds up to a sickly 3½% in total, or just over 0.3% a year. France, and the UK, have managed roughly 0.98% annualized growth over the same time. Comparing this to the US at 1.27% puts the exports-led growth fallacy into a clear perspective.

I wrote in these pages before that the real global divergence over the last 10 years has been driven not by the emerging economies decoupling from the US, but by Europe and Japan decoupling from the rest of the world. The chart above shows this, as the gap between European 'social' economies wealth and income and the US is still growing. But the chart also shows that Europe is having, once again, a much more pronounced recession than the US.

Europe's failure to keep up with the US during the last cycle is made even more spectacular by the political realities of the block. Unlike any other developed democracy in the world, EU has manged to produce numerous centralized plans for growth. Since the late 1990s, aping Nikita Khruschev's 'We will bury you!' address to the US, Brussels has managed to publish weighty tomes of lofty programmes - all explicitly aimed at overtaking the US in economic performance.

These invariably promised some new 'alternative' ways to growth nirvana. The Lisbon Agenda hodge-podge of “exporting out of the long stagnation” ideas was followed by the Social Economy theory that pushed the view that somehow, if Europeans ‘invest’ money they did not have on things that make life nicer and more pleasant for their ageing populations growth will happen. Brussels folks forgot to notice that ageing population doesn’t want more work, it wants more ‘free’ stuff like healthcare, public transport, social benefits, clean streets, museums and theatres. All the nice things that actually work only when the real economy is working to pay for them.

As if driven by the idea that economic development can be totally divorced from real businesses, investors and entrepreneurs, the wise men of Europe replaced the unworkable idea of Social Economy with an artificial construct labelled ‘Knowledge Economy’. This promised an exports-led growth fuelled by sales of goods and services in which we, the Europeans, are supposedly still competitive compared to our younger counterparts elsewhere around the world. No one in Brussels has bothered to check: are we really that good at knowledge to compete globally? We simply assumed that Asians, Americans, Latin Americans and the rest of the world are inferior to us in generating, commercializing, and monetizing knowledge. Exactly where we got this idea, remains unclear to me and to the majority of economists around the world.

The latest instalment in this mad carousel of economic programmes is this year's Agenda 2020 – a mash of all three previous strategies that failed individually and are now being served as an economically noxious cocktail of policy confusion, apathy and sloganeering.

But numbers do not lie. The real source of Euro area's crisis is a deeply rooted structural collapse of growth in real human capital and Total Factor productivities. And this collapse was triggered by decades of high taxation of productive economy to pay for various follies that have left European growth engines nearly completely dependent on exports. No amount of waterboarding of the real economy with cheap ECB cash, state bailouts and public deficits financing will get us out of this corner.

The real problem, of course, is bigger than the Eurozone itself. Exports-led economies can sustain long-run expansions only on the back of a borrowing boom in their trading partners. It is that simple, folks. Every time a Mercedes leaves Germany, somewhere else around the world, someone who intends to buy it will either have to draw down their savings or get a loan against future savings. Up until now, the two were inexorably linked through the global debt markets: as American consumers took out loans to buy German-made goods, Chinese savers bought US debt to gain security of their savings.

This debt-for-imports game is now on the verge of collapse. Not because the credit crunch dried out the supply of debt, but because the global debt mountain has now reached unsustainably high levels. The demand for more debt is no longer holding up. Global economic imbalances remain at unsustainable levels even through this crisis and even with the aggressive deleveraging in the banking systems outside the EU.

Take a look at the global debt situation as highlighted by the latest data on global debt levels. The first chart below shows the ratio of net importing countries’ gross external debt liabilities (combining all debts accumulated in public and private sectors, including financial institutions and monetary authorities) to that of their net exporting counterparts. The sample covers 20 largest importers and the same number of largest exporters.

Source: IMF/BIS/World Bank joint data base and author own calculations

As this figure illustrates, since mid-point of the last bubble at the end of 2005, the total external debt burden carried by the world’s importing countries has remained remarkably stable. In fact, as of Q3 2009, this ratio is just 0.3 percentage points below where it stood in the end of 2005. Compared to the peak of the bubble, the entire process of global deleveraging has cut the relative debt burden of the importing states by just 9.8%.

To put this number into perspective, while assets base of the world’s leading economies has fallen by approximately 35% during the crisis, their liabilities side has declined by less than 10%. If 2007 marked the moment when the world finally caved in under the weight of unsustainable debt piled on during the last credit boom, then at the end of 2009 the global economy looked only sicker in terms of long-run sustainability.

The picture is more mixed for the world’s most indebted economies.
Plotting the same ratio for the US and UK clearly shows that Obamanomics is not working – the US economy, despite massive writedowns of financial assets and spectacular bankruptcies of the last two years remains leveraged to the breaking point. The UK is fairing only marginally better.

Of course, Ireland is in the league of its own, as the country has managed to actually increase its overall share of global financial debt during this crisis courtesy of an out-of-control public expenditure and the lack of private sector deleveraging. Take an alternative look at the same data. Ireland’s gross external debt (liabilities) stood at a whooping USD 2.397 trillion in Q3 2009, up 10.8% on Q3 2007. Of these, roughly 45% accrue to the domestic economy (ex-IFSC), implying that Irish debt mountain stands at around USD 1.1 trillion or more than 6 times the amount of our annual national income.

Chart below shows gross external debt of a number of countries as a share of the world’s total debt mountain.
Source: IMF/BIS/World Bank joint data base and author own calculations

And this brings us to the singularly most unfavourable forecast this column has ever made in its 7 years-long history. Far from showing the signs of abating, the global crisis is now appearing to be at or near a new acceleration point. Given the long-running and deepening imbalances between growth-less net exporting states, like Germany, Japan and Italy and the net importers, like the US, we are now facing a distinct possibility of a worldwide economic depression, triggered by massive debt build up worldwide. No amount of competitive devaluations and cost deflation will get us out of this quagmire. And neither a Social Economy, nor Knowledge Economics are of any help here.

Paraphraisng Cypher in the original Matrix: “It means fasten your seat belt, Dorothy, ‘cause Kansas of debt-financed global trade flows is going bye-bye”.