31/8/2012: Eurocoin for August 2012

Euro area leading growth indicator from Banca d'Italia and CEPR has posted eleventh consecutive monthly contraction in August, reaching -0.33 from -0.24 in July. This marks the worst reading for eurocoin since July 2009. 2008-2009 average was -0.31, so the current reading is worse than average for the first wave of the crisis.

A year ago, the indicator stood at +0.22, implying a growth swing of 2.1-2.3% annual.

3moMA indicator is now at -0.25, annual expected rate of decline is at -1.3%.

Charts to illustrate:

31/8/2012: Net, gross, gloss - FDI in Ireland 2011

So CSO headlines today that Irish Net Direct Investment Position improved to €48 billion at the end of 2011. which is fine, until you read actual numbers. Here is the synopsis from CSO itself (emphasis is mine):

"Irish stocks of direct investment abroad fell by €12bn from an end-2010 position of €254.5bn to €242.5bn at the end of 2011. ...The decline between the end of 2010 and end of 2011 was mainly due to a fall in investment of €26bn in enterprises located in Central American Offshore countries. European based enterprises partially offset this decline."

Hence, Factor 1 - explaining most of the €7.2 billion in net position change is drop in investment schemes used by Irish resident companies to wash-off tax liabilities.

Next: "The level of total foreign direct investment into Ireland also fell between the end of 2010 and the end of 2011. The decrease was €19.2bn [massively in excess of net contraction in outward investment from Ireland] giving an end-2011 position of €194.5bn. The main contributors were decreases of €18bn from US and €10bn from Central America partially offset by increased investment of almost €20bn from European countries."

Hence, Factor 2 - FDI into Ireland has actually dropped, gross, by 9% year on year (please keep in mind, irish Government has cited increased FDI into Ireland as one core 'success' metric).


"Comparing the net end-year positions Ireland’s net FDI increased from €40.8bn at the end of 2010 to €48bn at end-2011."

I know I am supposed to be cheerful about the headline CSO produced, but...

31/8/2012: Poor newsflow for Friday

Clearly confidence-instilling newsflow from the euro area today:

"Euro area annual inflation is expected to be 2.6% in August 2012 according to a flash estimate issued by  Eurostat, the statistical office of the European Union. It was 2.4% in July."

ECB is expected to downgrade EZ growth forecasts once again, per this report.

"The euro area (EA17) seasonally-adjusted unemployment rate was 11.3% in July 2012, stable compared with June. It was 10.1% in July 2011. The EU27 unemployment rate was 10.4% in July 2012, also stable compared with June. It was 9.6% in July 2011." So the contagion to EU10 from EA17 is now feeding through.

And a scarier chart on youth unemployment via ZeroHedge:

And two charts to remind you where we are heading:

All of which is pretty much summarized in another blog post on euro area growth, here.

31/8/2012: James Hamilton on oil prices

An insightful (as always) and economically significant points raised in this interview (via OilPrice.com) by Prof. James Hamilton (UCSD and Econbrowser) on oil prices and demand/supply drivers:

• Why we shouldn't get too excited with the shale revolution
• The "Real" cause of high oil prices
• The incredible opportunity presented by natural gas
• Why long term oil prices will creep upwards
• The geopolitical hotspots that could cause an oil price spike
• Why sanctions could cause Iran to lash out
• Why speculators and oil companies are not to blame for high oil prices.
• Changes we can expect to see under a Romney Administration
• Why Short term oil price forecasts are worthless
• Peak oil & Daniel Yergin 

Certainly a worthy read.

31/8/2012: Financial Innovation : Positives v Negatives

Following on my previous post, here's a new paper by Frankin Allen titled "Trends in Financial Innovation and Their Welfare Impact: An Overview" (link here) published in the European Financial management (vol 18, issue 4).

Core paper findings are:

• "There is a fair amount of evidence that financial innovations are sometimes undertaken to create complexity and exploit the purchaser... As far as the financial crisis that started in 2007 is concerned, securitization and subprime mortgages may have exacerbated the problem.  
• "However, financial crises have occurred in a very wide range of circumstances, where these and other innovations were not important.  
• "There is evidence that in the long run financial liberalization has been more of a problem than financial innovation.  
• "There are also many financial innovations that have had a significant positive effect.  
• "These include venture capital and leveraged buyout funds to finance businesses.  In addition, financial innovation has allowed many improvements in the environment and in global health." 

The paper concludes that "On balance it seems likely its effects have been positive rather than negative."

I find the arguments strained. Much of the financial innovation that Allen declares to be positive is innovation that is driven directly by either force of the states or co-financed by the states. Thus these forms of innovation are not really innovative at all, but superficial. For example - debt-for-nature swaps are hardly a form of financial innovation but rather a form of state subsidy. Likewise, much of carbon permits trading is driven by restrictions imposed by the states via coercive systems. These might be positive - the point is not to dispute their social or environmental or economic value - but they are not what I would term 'financial innovations'.

About the only positive financial innovation that Allen cites that does not involve such state interventions is leveraged buyout. Allen does cite evidence that this had a positive effect, but in the periods immediately preceding some financial crises (the latest one being case in point, as was Japan's crisis of the 1990s and Nordic countries crises of the early 1990s etc) leveraged buyouts carry excessive leverage. Thus, the only unequivocally positive effect such buyouts might have at the times of rising debt overhang, in my view, is the effect of triggering future insolvencies that clear the path (via creative destruction) to new or more efficient incumbent firms growth. This positive effect, however, has little or nothing to do with the financial innovation per se.

Lastly, let me point that I am not disputing that some (the issue is really more of how much and of what variety) financial innovation is positive, but that Allen's article fails really to prove his hypothesis. Neither does it do any justice to the article to state that "the long run financial liberalization has been more of a problem than financial innovation" without actually proving this.

30/8/2012: Does Banking & Financial (De)regulation iImpact Income Inequality?

A new paper, titled "Bank Regulations and Income Inequality: Empirical Evidence", by Manthos D. Delis, Iftekhar Hasan and Pantelis Kazakis (Bank of Finland Research Discussion Paper 18/2012, linked here) studied the effects of financial regulations (deregulation) on income inequality in 91 countries over the period of 1973-2005.

The study yields some very interesting results (emphasis is mine):

• "In general, the liberalization policies from the 1970s through the early 2000s have contributed significantly to containing income inequality."
• "... Abolishing credit controls decreases income inequality substantially, and this effect is long- lasting."
• "Interest-rate controls and tighter banking supervision decrease income inequality; however, these effects fade away in the long term."
• "For banking supervision, the negative effect on inequality [higher supervision leads to lower inequality] is reversed in the long run, a pattern associated with stricter capital requirements that tend to lower the availability of credit". 
• "... Abolishing entry barriers and enhancing privatization laws seem to lower income inequality only in developed countries."
• "... The liberalization of securities markets {expanding securitization] increases income inequality." 

What are the policy implications of these findings?

• "Bank regulations and associated reforms aim at enhancing the creditworthiness of banks and at improving the stability of the financial sector. Several studies over the last decade show that regulations do matter in shaping bank risk (e.g., Laeven and Levine, 2009; Agoraki et al., 2009) or in affecting bank efficiency (Barth et al., 2010) and the probability of banking crises (e.g., Barth et al., 2008)."
• "Yet, what if bank regulations have other real effects on the economy besides those associated with banking stability? And, more important, what if these real effects counteract the intended stabilizing effects?"

Two issues should be considered in answering these questions:

1. "The literature on the relationship between bank regulations and financial stability is inconclusive. In fact, different types of regulation may have opposing effects on financial stability, according to the existing research."
2. "... even if we assume that bank regulations like more stringent market-discipline requirements lower banks' risk-taking appetite and enhance stability (Barth et al., 2008), the empirical findings here suggest that these effects are asymmetric and certain liberalization policies (i.e., liberalization of securities markets) or regulation policies (i.e., higher capital requirements) actually increase income inequality. That is, banks pass the increased costs of higher risks (coming from the liberalization of securities markets) and higher capital requirements on to the relatively lower-income population that lacks good credit and collateral. In other words a trade-off between banking stability and inequality may be present" [Note: this trade-off, I would argue, is most certainly a problem for Ireland today, with future borrowers operating in the environment of reduced family wealth due to property bust and financial assets depletion]. 

"Given the contemporary discussion surrounding (i) the rebirth of Glass-Steagall-type regulatory reforms as they relate to securities trading, and (ii) the discussions under Basel III to increase the risk-adjusted capital base of banks, there may be more to think about before taking those steps."

"On the good side, three clear suggestions emerge from this paper and are also consistent with the findings of Beck et al. (2010)": 

1. "... the liberalization of banking markets, primarily through abolition of credit controls, helps the poor get easier access to credit. This in turn allows them to escape the poverty trap and substantially raise their incomes." 
2. "... appropriate prudential regulation should provide less costly incentives to banks to increase regulatory discipline without hurting the relatively poor. Information technologies that would lower the cost of transparency and more effective onsite supervision that would enhance the trust in the banking system may help achieve this goal."
3. "... economies first need a certain level of economic and institutional development to see any positive effect of the abolishment of entry restrictions and privatizations on equality..."

30/8/2012: 22 quarters of Europe standing still

2007-present is the period during which the advanced economies world barely moved in terms of economic growth. And this is true especially for the EU27 and the euro area 17. The next three charts document the 22 quarters during which Europe stood still:

(All charts represent author own calculations based on data sourced from the OECD)

29/8/2012: Some facts about Irish average earnings: Q2 2012

Q2 2012 earnings and working hours data for Ireland has been released today by the CSO. Here are top changes and trends:

• Average hourly earnings were €21.91 in Q2 2012 compared with €21.90 in Q1 2011, representing no real change over the year. [Note: either CSO has not heard of inflation, or there was no inflation in Ireland Q2 2011-Q2 2012]
• Average weekly paid hours were 31.4 in Q2 2012, which was the same as those recorded in Q2 2011.
• Public sector numbers were 380,800 in Q2 2012, a fall of 25,800 (-6.3%) from Q2 2011 when the total was 406,600 (including temporary Census field staff).

The above are straight from CSO analysis. Excluding census workers, public sector (including semi-states) employment stood at 380,800 in Q2 2012 down on 401,300 in Q2 2011 and on 421,400 in Q2 2008 - a decline of 20,500 y/y of which 17,600 came from outside semi-state bodies.

Table below lists changes in earnings in broad sectors:

However, on aggregate, year on year to Q2 2012, per CSO:

• Weekly earnings in the private sector fell by 0.5% annually, compared with an increase of 2.8% in the public sector (including semi-state organisations) over the year, bringing, average weekly earnings in Q2 2012 to €611.66 and €918.99 respectively. 
• In the three years to Q2 2012 public sector earnings have fallen by €27.10 (-2.9%). This compares with a decrease of €24.95 (-3.9%) in private sector average weekly earnings in the four years since Q2 2008.

Here's the chart showing decomposition / breakdown of declines in public sector employment:

In Q2 2009, the peak year for average weekly earnings in the public sector, the gap between private sector average weekly earnings (€618.08) and public sector average weekly earnings (€946.09) was 53.07% in favour of the latter. In Q2 2012 the gap was 50.3% - slightly smaller, but not significantly so and factoring in that between 2009 and 2012 many more senior (higher paid and more experienced) public sector employees have retired (including via incentivized early retirement schemes), leaving the workforce in the public sector less skilled and experienced than it was in 2009, the gap has probably increased, like-for-like. Also, the same is exacerbated by the heavy younger workers losses of jobs in the private sector, which has left private sector workforce on average probably more experienced and senior in tenure than prior to the crisis.

In Q2 2008, the gap was 46.2% which was lower than what we are observing today.

Remember, we are being told that everyone should take proportional 'pain'...

29/8/2012: Spot that 'engine for growth'

We keep hearing, usually from the European officials, and at times of referenda - from domestic politicians - that the EU and the euro are the drivers for growth and prosperity. Even today, in his op-ed, ECB chief Mario Draghi referenced euro as a driver of prosperity.

So let's do a simple exercise, take pre-crisis peak and history of growth in nominal euro area GDP and see where would the region have been if it were an 'engine for growth' comparable to relatively weak G7 states (A2), other advanced economies ex-G7 and the euro area (A1), and 1990-2009 world growth average (A3).

Chart below illustrates:

Here's an interesting fact: the advanced economies ex-G7 and euro area path, even after the crisis is factored in is almost identical to the world growth path. But the euro area path is underperforming the G7 path by 2 years in terms of regaining the pre-crisis peak.

Note: all data is taken from and/or computed on the absis of the IMF WEO database.

Caveats are many - this is hardly a deep analysis, so be warned. But by any comparatives, this does not support the proposition of the euro area as an engine for growth.

Let's do another mental exercise. Suppose we ignore the fact that euro area actually expanded since 2004 in terms of membership 9adding very insignificant overall boost to the region GDP of 1.5-1.7%). Assume that post 2004 there are two possible growth rates that apply:

• Average growth rate between 1993 and 2004 to reflect pre-euro area era and
• Average growth rate for 2004-2012 to reflect euro area era

Here's where the two assumptions lead us:

Again, where's that engine for growth?

Please note: the argument that 'absent euro things would/could have been much worse' is vacuous. We don't say Mercedes AMG is an 'engine for speed' by implying that it delivers non-zero speed. We claim this by comparatives to other functioning vehicles.

Lastly, let's compare like-for like. Here's actual (including IMF forecasts for 2012-2017) GDP data for G7 countries (excluding Germany, France and Italy), and EA3 members of G7 (Germany, France and Italy), with an added line for G7 countries ex-EA3 and Japan:

Obviously, an engine for growth should have at very least achieved some comparable performance for EA3 to that of its peers? Err... not really. And worse, taking 1999 as a base date (the year of EA3 adopting the euro officially) yields very similar qualitative results.

29/8/2012: Slovenia & Ireland lead in banks-related risks

According to latest data from the Euromoney, Slovenia now leads the rise in bank-related risks in Europe. Here's a chart mapping declines in scores across Europe (lower score implies higher risk):

It is worth noting that Ireland shows the second largest risk increase  after Slovenia in absolute level terms, but the largest in percentage terms.

29/8/2012: H1 figures for trade show effect of the patent cliff

A very good analysis of Irish external trade figures for trade in goods and the effect of the patent cliff on trade balance from Dr. Chris van Egeraat, Department of Geography and NIRSA, NUI Maynooth in FinFacts today: link here. 

Readers of this blog and my (now sadly defunct) Sunday Times column would have spotted my interest in the subject. Dr Van Egeraat presents H1 figures for 2012 - first available this month - to show the effect.

29/8/2012: Corporate Governance & Transparency in EU27

A new study, published in the International Journal of Business Research (link here), has ranked 27 EU countries' corporate governance codes in terms of transparency levels required. According to authors, the empirical study conducted "that approaches corporate governance from regulatory perspective ...by analyzing all codes currently enforceable at European Union level, has two main goals focused on transparency and disclosure provisions settled by these" which implies that the study is "more comprehensive in these respects than prior related research focused on the same topic".

The main aspect of the study is "to define particular [corporate governance & transparency] disclosure groups [of countries] according to the level of transparency required and to classify all analyzed codes into these clusters."

The study modeled "the average value of disclosure indices for each disclosure group created" (Avg.D&T S_Index), basically as a metric of "similitude between them and OECD principles as regards the compliance with disclosure and transparency requirements".

"Consequently, we divided our sample of corporate governance codes according to their disclosure indices into six different groups revealing a level of disclosure from "very high level" to "insignificant level". The distribution of corporate governance codes into the disclosure groups thus created are presented in Table III, together with the average values of disclosure indices calculated for each group (Avg.D&T S_Index) and the average scores for the independent variables, revealing the level of disclosure depending on codes' issuers type (IT) and countries' legal regimes (LR1 and [LR.sub.1])." 

In the above 

• "IT (Issuer Type), the following four identities being considered: "Composite", made of groups that contain representatives from at least two of the subsequent groups, "Government", referring to national legislatures or governmental commission/ministries, "Exchange", represented by national stock exchanges and "Industry", referring to industry or trade associations and groups, as in prior related literature;"
• "LR (Legal Regime), in this respect being used classifications made by both La Porta, et al. (1997), who distinguished between "Common law", "German civil", "French civil", "Former socialist" and "Scandinavian civil" (values assigned to variable LR1) and Cicon et al. (2010), who introduced two new legal regimes ("Baltic civil" and "Global governance practices") instead of "Former socialist" and "Scandinavian civil" (values assigned to variable [LR.sub.2])."

Here are the summary table for groups assignments:

Now, the above suggests that Ireland has the lowest possible - "Insignificant Level" - of corporate disclosure rules compared to the OECD best practices standards. The results also show that Ireland does not belong to the group of highest disclosure-consistent legal regime (LR) that includes Common Law-type countries, but instead belongs to the lowest level of legal regime-consistent transparency.

28/8/2012: Debt- v Equity-led Funding and Systemic Crises

Apparently, there's been some serious movements in today's banks CDS, signaling some pressure building up in the system and potentially a disconnect between equity markets and bond markets. This wouldn't be the first time the two are mis-firing in an almost random fashion. In the longer-term, however, such episodes are very troubling for a good reason - long term imbalances build up in the two sources of capital funding is hard to unwind. It turns out, however, the difficulty of unwinding these is non-symmetric.

Last week's NBER Working Paper number 18329 (link here), titled "Debt- and Equity-led Capital Flow Episodes" by Kristin J. Forbes and Francis E. Warnock looked at "the episodes of extreme capital flow movements—surges, stops, flight, and retrenchment... [leading to] the question of":

• Which types of capital flows are driving the episodes and 
• If debt- ( bonds and banking flows) and equity-led (portfolio equity and FDI) episodes differ in material ways. 

"After identifying debt- and equity-led episodes, we find that most episodes of extreme capital flow movements around the world are debt-led and the factors associated with debt-led episodes are similar to the factors behind episodes identified with aggregate capital flow data. In contrast, equity-led episodes are less frequent, more idiosyncratic, and differ in nature from other episodes."

The study uses data on 50 emerging and developed countries starting with 1980 (at the earliest) and running through 2009.

The study found that "the vast majority of extreme capital flow episodes across our sample—80% 

of inflow episodes (surges and stops) and 70% of outflow episodes (flight and retrenchments)—are 
fueled by debt, not equity, flows."

After that, the paper develops analysis of "the factors that are associated with debt- and equity-led episodes of extreme capital flows. We follow the Forbes and Warnock (2012) analysis here by describing capital flow episodes as being driven by specific global factors, contagion, 

and/or domestic factors." 

The study found that: "to a first approximation equity-led episodes appear to be idiosyncratic, bearing 
little systematic relation to our explanatory variables. Notably, even the risk measures that were 
highlighted in Forbes and Warnock (2012) as being significantly related to extreme movements in 
aggregate capital flows have little or no significant relationship with equity-led episodes. In contrast, 
risk measures are important in explaining debt-led episodes; when risk aversion is high, debt-led surges 
are less likely and debt-led stops are more likely. Contagion, especially regional, is also important for 
debt-led episodes. Country-level variables are largely insignificant, except for domestic growth shocks; 
debt-led stops are more likely in countries experiencing a negative growth shock and debt-led surges are more likely in countries with a positive growth shock."

Perhaps in a warning to the policymakers currently embarking on financial repression path for dealing with the ongoing crises, "capital controls have little or no significance in  both equity-led and debt-led episodes, as also found in Forbes and Warnock (2012)."

Of course, we have to keep in mind that the current crisis is really a debt-led capital markets crisis, both at the corporate and sovereigns levels. And it is symmetric both for the US and Europe, where the main difference is not as much in equity vs debt financing, but in intermediated vs direct debt issuance.

28/8/2012: Challenging 'perpetual growth' hypothesis

Once in a while, there is a fascinating piece of thinking that focuses on the long-term economic trends that is worth reading. Robert J. Gordon's "Is the US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds" (NBER working paper 18315 published last week - link here) is exactly that.

The study looks at an exceptionally complex issue of long-term (centuries-long) trends in growth from the point of questioning the basic premise of economics - the premise that future growth is a 'continuous process that will persist forever'.

Quoting from the paper, the author establishes the following basic points concerning the prospects for future growth (up to 50 years out from 2007 and abstracting from the fallout from the ongoing crisis):

1. "Since Solow’s seminal work in the 1950s, economic growth has been regarded as a continuous process that will persist forever.  But there was virtually no economic growth before 1750, suggesting that the rapid progress made over the past 250 years could well be a unique episode in human history rather than a guarantee of endless future advance at the same rate."
2. "The frontier established by the U.S. for output per capita, and the U. K. before it, gradually began to grow more rapidly after 1750, reached its fastest growth rate in the middle of the 20th century, and has slowed down since.  It is in the process of slowing down further."
3. "A useful organizing principle to understand the pace of growth since 1750 is the sequence of three industrial revolutions. The first (IR #1) with its main inventions between 1750 and 1830 created steam engines, cotton spinning, and railroads. The second (IR #2) was the most important, with its three central inventions of electricity, the internal combustion engine, and running water with indoor plumbing, in the relatively short interval of 1870 to 1900.  Both the first two revolutions required about 100 years for their full effects to percolate through the economy. During the two decades 1950-70 the benefits of the IR #2 were still transforming the economy, including air conditioning, home appliances, and the interstate highway system. After 1970 productivity growth slowed markedly, most plausibly because the main ideas of IR #2 had by and large been implemented by then."
4. "The computer and Internet revolution (IR #3) began around 1960 and reached its climax in the dot.com era of the late 1990s, but its main impact on productivity has withered away in the past eight years.  Many of the inventions that replaced tedious and repetitive clerical labor by computers happened a long time ago, in the 1970s and 1980s.  Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it."
5. "... It is useful to think of the innovative process as a series of discrete inventions followed by incremental improvements which ultimately tap the full potential of the initial invention. For the first two industrial revolutions, the incremental follow-up process lasted at least 100 years. For the more recent IR #3, the follow-up process was much faster. Taking the inventions and their follow-up improvements together, many of these processes could happen only once. Notable examples are speed of travel, temperature of interior space, and urbanization itself."
6. "The benefits of ongoing innovation on the standard of living will not stop and will continue, albeit at a slower pace than in the past. But future growth will be held back from the potential fruits of innovation by six “headwinds” buffeting the U.S. economy, some of which are shared in common with other countries and others are uniquely American.  Future growth in real GDP per capita will be slower than in any extended period since the late 19th century, and growth in real consumption per capita for the bottom 99 percent of the income distribution will be even slower than that." 
7. "The headwinds [to growth] include the end of the “demographic dividend;” rising inequality; factor price equalization stemming from the interplay between globalization and the Internet; the twin educational problems of cost inflation in higher education and poor secondary student performance; the consequences of environmental regulations and taxes that will make growth harder to achieve than a century ago; and the overhang of consumer and government debt.  All of these problems were already evident in 2007, and it simplifies our thinking about long-run growth to pretend that the post-2007 crisis did not happen."

An interesting and highly illustrative chart plotting growth evolution:

And the conclusion? "A provocative “exercise in subtraction” suggests that future growth in consumption per capita for the bottom 99 percent of the income distribution could fall below 0.5 percent per year for an extended period of decades." Illustrated here:

27/8/2012: Second worst in GDP growth in Q1 2012?

When on July 12 the CSO published the latest Quarterly National Accounts, the Irish media and the Government were quick to focus on the positive side of the reported data - the revised figures for Q4 2011 that Irish GDP rose 1.4% in constant prices terms y/y in 2011 compared to 2010. Fr less attention was paid to a massive 2.5% y/y fall off in GNP and even less attention still was given to Q1 2012 preliminary estimates that showed q/q contractions in GDP of 1.1% and in GNP of 1.3%. All in, the headline figure referenced was almost always the up-beat "Irish economy grew at a euro area average rate in 2011".

Now, there are many caveats that should accompany q/q figures, including:

• Q/q changes can be volatile;
• Preliminary figures can be subject to significant revisions in the future; etc

Keeping all of this in mind, today's data release from the OECD is discomforting. Here's the chart:

As the chart above clearly shows, excluding Greece (missing data), we are the second worst performer (after Luxembourg) in terms of GDP growth in Q1 2012 in the entire OECD.

Let's hope those future revisions come in to the significant upside.

27/8/2012: Mid-Term Forecasts for Russian Ruble: Capital Economics

An interesting view on the Russian ruble medium term outlook was published in the ECR weekly monitor arguing that as USD/Euro moves to dollar strengthening, we can expect devaluation of the ruble vis dollar by ca 10% over the coming 18 months. Liza Ermolenko, economist with Capital Economics, provided three core reasons for devaluation:

1. Expected intensification of the euro area crisis will likely weigh on Russian exports just as the Central Bank of Russia (CBR) is reducing market interventions in support of ruble and is aiming to widen the currency band. Monetary conditions are expected to stay relatively stable, according to Ermolenko, as fiscal spending will also remain constrained.
2. Deterioration in Russia's balance of payments due to fast growth in imports, and possible fall in oil prices to USD85 pb by the end of 2012. Capital Economics projects Russia's current account surplus to fall to 3.5% of GDP in 2012 from 5.5% in 2011, with a possibility of posting a small deficit in 2014.
3. Long term competitiveness is deteriorating in Russia, as the economy gave up productivity and cost competitiveness gains of 2008-2009 crisis period to higher inflation. "Real exchange rate [linked to consumer prices] is now back to where it was in mid-2008", according to Ermolenko.

So Ermolenko forecasts 5% decline in the ruble against the euro/dollar basket by the end of 2012 and a similar decline in 2013, with most of the decline driven by devaluation against the USD. Target is Rb35.5/USD by end-2012 and Rb38.5/USD by end-2013 from current Rb31.9/USD. Euro forecasts are for slight devaluation to Rb39.0/Euro by end-2012 followed by appreciation to Rb38.5/Euro by end-2013, compared to Rb39.4/Euro current.

26/8/2012: An outlier

Check out this chart (courtesy of http://macromon.wordpress.com/2012/08/26/week-in-review-35/wir_equity_ytd-52/ ):

26/8/2012: The way of Berlin in Greek drama

"Those whom the gods wich to destroy, they first make mad" is a proverb that is commonly, but possibly mistakenly, attributed to Euripides, who was, by all official accounts, a Greek, to the bone. In modern parlance - a European, more than that, an ancestor to those we now call citizens of a member state of the euro area, and Schengen, the arrangements that distinguish them as being the members of the European Core. That, and, ... oh one of the three fathers of Greek - Athenian - tragedy.

But enough with history. Whether Euripides authored the above statement or not, it pretty certainly came from Greece. Sophocles uses a similar phrase in Antigone, which pre-dates Euripides' plays.

The latest revival of the rather dated by now idea of granting the European Court of Justice (ECJ) the powers to "monitor the budgets of the member states and punish those that run up a deficit" (reported here) is the case proving the above conjecture.

The extension of such powers would make the ECJ the only court system with the power to oversee and directly influence the fiscal policy of the sovereign states. It will also be the only power that will be allowed to impose sanctions on sovereign states. Even the IMF has no power of similar nature vis-a-vis the states.

But there is more to the above equation. The ECJ is a court, here to decide on the matters relating to the law. Giving it any power resting outside its remit both undermines the system of checks and balances that normally constitute the foundation of any state, and, as the result undermines the legitimacy of the court itself. Blending of the boundaries between the executive (fiscal authority), the legislature (power to budget), and the judiciary delegitimizes all three.

And exactly the same, in my view, applies to the fiscal supervision and oversight powers to be vested with the ECB per another recent plan. No Central Bank in the advanced world has such powers of control over the fiscal policies of the state. You can call it a 'Dictator Draghi' case, but humor aside, the remit creep infecting Europe today is worrisome.

The euro area lead states - Germany in particular - are now locked in a frantic drive to build up institutional solutions to the problem created by the poor design of the common currency union over fifteen years ago. These solutions are not only unlikely to work, but the method of arriving at them is now risking to undermine the still-functional institutions of the European Union as a whole.

Irony has it, we have to turn to Greeks to spot the trend in gods work.

26/8/2012: Holding Pussy Riot mirror up to European demagogues

One of the absolute best analytical pieces written on the Pussy Riot is this post by Mary Ellen Synon. Mary Ellen superbly connects the narrow context of the Pussy Riot immediate case and verdict to the much broader geopolitical reality that shaped the 'Western' or the 'European' quasi-hysterical response to it.

A mirror put in front of our own faces this is - a question that we must ask ourselves - is it the real pursuit of liberty that drives our occasionally misguided and often counter-productive mainstream analysis that see only evil in Russian State attempts to reconstruct itself and the national identity? Or is it driven by our biases that perfectly allow adoration of totalitarian Cuba, admiration for the Chinese 'economic miracle' built on the foundations of denying property and basic human rights to millions of Chinese citizens, unquestioning support for the cult of victimhood for often internecine and quasi-nazi 'liberation' movements around the world, our 'European' sympathies awarded to those who advocate, in fact, the destruction of democratic states, and the denigration and debasement of the very values of inclusiveness and tolerance we hold so dear in Europe itself?

Whether you agree with the facts stated in the article or not, it is never a bad thing to look at ourselves in a mirror to check for signs of ethical duplicity.

PS: To put it on the record, my view has been publicly expressed on the topic of the Pussy Riot conviction and sentencing. Here are sm snapshots from the record:

26/8/2012: ECB letter - what Minister Noonan's latest conversion tells us about the State

There is anew circus in downtown Dublin and this time around it is the courtesy of the old culprit the infamous ECB letter from Trichet to the late Minister for Finance, Brian Lenihan.

The letter was (again, for the n-th time) brought to our attention by Professor Karl Whelan in his forbes.com post (here) and the issue championed by Gavin Sheridan of gavinsblog and http://www.thestory.ie. This time around the mention raised some noises from the Minister for Finance Michael Noonan (here).

We can only speculate as to Minister Noonan's motives for promising, at last, to publish this letter. My suspicion is two-fold:

1. Nothing penetrates the skulls of Irish establishment other than bad publicity in international press. Frankly put, years of criticising Governments policies have taught me several lessons. One of them is that an article in the Irish Times causes an 'outrage' and 'indignant' denials. An article in the likes of Forbes or Wall Street Journal or FT causes real 'concerns'. Ireland's elites are incapable of reassessing their adopted positions (on policy or transparency or anything else) unless their silence can damage their standing with the MNCs and within international community.
2. We might be getting a pre-management of what is likely to be a fizzling-out of the Government efforts to deliver on the 'seismic' June 29 EU summit commitment 'to re-examine' Irish banks bailouts.

The above are speculative arguments, solely to raise some questions, but the change in Minister Noonan's rhetoric is indeed rather dramatic. 

Italy received a similar letter and it was leaked to the press back in August 2011 (see here). The world didn't end and Italian economy did not collapse. ATMs still function. The ECB sent a similar (in nature) letter to Spain, and that letter remains undisclosed to the public. Minister Noonan could, in my view, make the letter fully public at any moment in time by simply ordering it to be published. All that stands between Minister Noonan's stated intention of publishing the letter and the actual publication of the letter is... err... Minister Noonan's will.

Of course, for historical reasons and for the sake of transparency, the ECB letter is important. As an aid to securing Ireland's future, it is relevant only in so far as it raises real questions relating to the competence of our permanent 'elite' - the Government advisers and the senior civil servants. 

What concerns me most is the mythology of the nation that will have to be destroyed if the letter really does contain a threat from the ECB of the withdrawal of ELA or funding for Irish banks in response to any unilateral action taken against the banks bondholders. The mythology at risk here is that the then Minister for Finance, and his advisers and the Department, plus the Central Bank and other authorities of the Irish State actually acted within the full extent of their capabilities in protecting the interest of the taxpayers and the State.

Think about it: can such a threat from the ECB be credible? 

The alleged threat contained in the ECB letter is that the ECB were to turn off the liquidity taps to Irish banking system because imposing haircuts on banks bondholders would have risked a full contagion from Irish banks to the Euro system or its financial system at large. Suppose this is so. Surely, turning off the liquidity tap in such a case would have risked a full-blown and immediate collapse of the entire Irish banking system (as opposed to the partial insolvency triggered in some banks by bondholders actions) - the very same system that is, allegedly, so vital to the European banking system that even a handful of disgruntled bondholders relating to Irish banks could trigger a run on the European banking. 

This is (a) highly alogical, and (b) unlikely to have passed the ECB council vote.

Worse than that: such a threat would have forced Ireland to exit the Euro system and monetize the banking system with own currency - an event that would have threatened much more than just the stability of the Euro area banking system, but the existence of the Euro as a currency.

Thus, if the threat contained in the letter is that of the liquidity starvation, such a threat could not have been credible when it was made. Which implies that either the letter contains some other threat, or that the Government at the time was simply out of its depth in dealing with the crisis.Setting aside, for now, the possibility of the former, the latter, if true raises another set of questions: Where were the Government advisers (especially the ones who are today still in the position of considerable power and authority)? Where were the senior civil servants (pretty much all of whom are still in the positions of considerable power and authority)? 

You see, incompetence of the Government ends with the Government replacement by the voters. Politicians, in the end are accountable. 

Incompetence of the permanent elite (senior civil servants and advisers in charge of steering the Minister response) continues as long as they remain in the positions of authority and then, beyond, into their handsomely rewarded retirement. The former aspect of the letter is stuff for historians, the latter is for us.

25/8/2012: August 2012 MOU - a base PR touch with little substance

The new installment of the Comics, known as Ireland's MOU (Memorandum of Understanding) with Troika was quietly released yesterday, without so much as giving the media an embargoed copy or a prior notice of forthcoming release (see The Irish Times article on this).

The document was (once again) released in a pdf format that is unmanageable in the Professional version of the software, cannot be searched, cannot be easily scrolled through and loads partially possibly due to non-optimized version saved by the Department of Finance. In simple terms - the release was antediluvian in presentation - a veritable embarrassment to the Government that keeps talking about modernization in the Civil Service etc.

In terms of content, there are some comical moments of  a truly priceless nature. In the week that saw publication of the Central Bank report on Irish banks lending to the SMEs, identifying Ireland as the second worst performer in this area after Greece, the MOU opens up with the following statement, concerning targets delivery by the end of Q3 2012 [emphasis mine, throughout]:
"The authorities... will assess banks' deleveraging ... in line with 2011 Financial Measures Programme. Fire sales of assets will be avoided, as will any excessive deleveraging of core portfolios, so as not to impair the flow of credit to the domestic economy."

Furthermore, in light of the abysmal Q2 2012 data for mortgages arrears and defaults, also released this week, the MOU states: "The authorities will provide staff of the EU Commission, the IMF, and the ECB with their assessment of banks' performance with the work-out of their non-performing mortgage portfolios in accordance with the agreed key performance indicators." One wonders if the 'assessment' of performance will reference the fact that more than 1/2 of all restructured mortgages are now back in arrears (see details here).


As far as a pertinent or substantive part of the 'Financial Sector Reforms', the MOU lists (should we be surprised) only one real tangible measure to be delivered on: "The authorities will also adopt regulations underpinning the Resolution Fund Levy to recoup Exchequer resources provided for the resolution of troubled credit unions." Congratulations to the Government on consistent continuation of the core 'reforms' policy in all spheres of the Irish economy - identification of new taxes/levies/charges to milk the taxpayers. Incidentally, the Levy was not mentioned under the respective heading in MOU from May 2012.


Structural reforms section of the MOU is worth some attention, as always, if only for the complete waffle it contains. Promises to monitor, to report are thick on the paper, but details of any actual reforms are thin. As always, the MOU is really about managing PR for Ireland-Troika relations, not for actual reporting (which takes place much more via ongoing monitoring and Troika reviews).


On personal debt issues, "the authorities will ensure that a programme to facilitate access by distressed borrowers to professional advisory services, funded by banks, will be operational". Of course, not a word on such services needing to be independent of banks in the front section of the MOU, although the said reference is contained in the latter sections. In addition, one has to wonder - the scheme is not operational now and how it can be made operational between last Friday and next Thursday is anybody's guess.


On social 'support' scheme efficiencies (aka social welfare): the set of reporting targets is identical to that provided in May 2012 and majority of these targets remain unaddressed, judging by the CSO data. For example, the MOU promises progress on "Reducing the average duration of staying on the live register." The said duration is continuing to increase. MOU claims to report progress on "Increasing the fraction of vacancies filled off the live register", but there is still no actual data on this reported by the CSO - the official source for Live Register stats. "Increasing the number of unemployed referred to training courses and employment supports" in reality, per latest CSO data, is met with decreasing numbers of those in state training schemes. As per "Providing data on live register broken down by continuous duration, and probability of exit by various durations"... well, the former is normally supplied by the CSO (so no need for MOU-linked reporting) and the latter... oh, may be the Department of Finance can point me to where that has been supplied. Data 'per exit destination' from the unemployment supports - promised by the MOU - is still nowhere to be seen, as far as I know.

Since May 2012, the state was tasked to provide simple stats on evaluation of activation and training policies. As far as I know, this still has not been fully complied with.


When it comes to fiscal 'reforms' there are no new targets for either numerical tax increases (still set at "at least €1.25bn") nor for voted expenditure "consolidation measures" (still at €2.25 bn). Some folks have suggested that the numbers represent scaremongering by the Government in advance of the Budget 2013, but I must disagree - the targets were set ages ago and so far these have not changed.

There is an interesting change of course on the state asset disposals procedures for Q4 2012 MOU compliance plan, which now reads "Government will complete, if necessary, relevant regulatory, legislative, corporate governance and financial reforms required to bring to the point of sale the assets it has identified for disposal". The new bit here is the insertion of "if necessary" clause in place of March 2012 version which read "...will complete the identified regulatory..." In other words, the Government is seemingly lowering the bar for compliance with normal disposal practices.


Despite having more staff per supervised institution than any other Central Bank in the developed world, the Irish Central Bank gets 5 days extension on regular submissions of two core datasets: set C3 and C7 relating to detailed financial and regulatory information on domestic individual Irish banks etc, and deleveraging reports. Surely, not a good sign for the CBofI productivity...


Some of the best examples of the Government spin and distortion of reality are, as always, found in the Attachment 1. Memorandum of economic and Financial Policies.

Take these for examples:

• The Government reports the return of economy to growth in 2011, but, given this is now August, mentions nothing about the economic decline in Q1 2012 or about the economic conditions since.
• The Government reports a current account surplus in reference to GNP, but does not reference growth rates in GNP terms.
• The Government states that "domestic demand continues to decline - albeit at a slowing pace - owing to continuing household balance sheet repair and the still weak labour market." It fails to include in the causes of the domestic demand decline Government-own taxation policies and inflationary pressures from state-controlled sectors. That said, the Government does admit that 'administered price increases' have lifted HICP to 1.8% in H1 2012.
• The MOU states that "weak trading partner growth dampening export demand eve as further competitiveness improvements cushion this effect". This statement is pure spin, as the declines in our exports are registered in the pharma and related organic chemicals sectors where not the demand weakness, but patents expiry is the core driver. Our competitiveness gains have been flattening out or declining on productivity side, but are improving on forex side.

The MOU now explicitly references only two targets for 'addressing banks-related debts' legacy - Anglo promo notes and PTSB, which has been flagged as a scaling back of Government expectations post June 29 summit announcement already, so no surprise there.

Aside from the above, I can spot no significant changes in the current MOU compared to May 2012 MOU. The same applies to small / marginal changes in the technical MOU. Here is an example where the larger scale changes can be found (although even these are very insignificant):

24/8/2012: Perverse logic of Berlin?

An interesting article in the Irish Times today (link) quoting Germany's Fin Min on Irish debt-relief proposals, saying that Ireland's "massive" reform progress should not be compromised by the country efforts to gain relief on banks-related sovereign debts. From the Irish Times: "We cannot do anything that generates new uncertainty on the financial markets and lose trust, which Ireland is just at the point of winning back."

While we should be careful not to read too deeply into Mr Schauble's comments - which can be interpreted in a number of ways - the logic of the German Fin Min is worrisome.

Ireland has raised exceedingly expensive funds in recent bonds and T-bills auctions with explicit desire to test the markets appetite for Irish paper. In many ways, the relative success of these auctions was underwritten by external dynamics in debt markets, but also by the markets perception of Irish progress on reforms and by the markets expectation of the decline in future debt liabilities related to the banks debt deal. In other words, Ireland has paid a hefty price so far for starting the process of recovering some market access for the Sovereign. This is a net positive, albeit severely limited by the cost of funding raised.

Hence, we have a bizarre situation:

1. a member state in the Euro zone is undertaking all the right (from the markets & policymakers point of view) steps, achieving measurable progress, and generally behaving like the best pupil in the class, yet 
2. German leadership - the proxy for the Euro zone leadership - is unwilling to help that state in its efforts.

Surely, if Germany really wants stabilization and recovery in Europe's periphery, writing down €30 billion of promissory notes would be the cheapest approach to take toward reinforcing Irish efforts to deliver on the programme. Since the funds are fully linked to the ELA, this would imply absolutely no negative effect on private markets expectations. If anything, it will signal Europe's willingness to use the monetary system to support the process of resolving banking insolvency-induced stress on the sovereigns. Reduction in Ireland's debt burden in this context will be non-trivial and will help restore bonds markets confidence in both Ireland and the Euro zone system.

The bond markets operate - basically speaking - at the following level of logic:

• If an action reduces supply of debt, ceteris paribus, price of debt goes up, yields go down. Restructuring Irish Government's banks-linked debt will act to deliver exactly this effect.
• If an action reduces future potential haircuts that can expected by the private sector holders of debt in the event of prababilistic restructuring, price of debt goes up and yields go down, since future expected losses on privately held debt will be lower. Restructuring officially (Euro system) held ELA will deliver exactly this.
• If an action improves debt sustainability of the sovereign, yields will go down. Restructuring ELA will do exactly this.
• If an action does not introduce new moral hazard into future funding incentives for the sovereign, longer-term yields will be lower. By restructuring ELA - which has nothing to do with Irish exchequer past poor performance or policy choices, but has to do with rescuing risk-taking behaviour of the foreign funders of the Irish banks - the Euro zone can achieve exactly such long-term consistent repricing of Irish debt.
• If an action reduces the need for future funding, expected future bonds issuance falls and with it, the yields will fall. By removing the need to fund future repayments of promissory notes, the EU can achieve exactly this effect.
• If an action improves economic growth prospects for the nation, thus lowering risks associated with future tax revenues growth, deficits and debt financing, it will reduce yields on Government debt. This, again, is something that a restructuring of ELA/promissory notes will achieve.

Any way you spin it, aggressively restructuring the promissory notes and the ELA will deliver the benefits for the Irish exchequer. If, as Mr Schauble clearly believes, there is a case for contagion of risks across the peripheral sovereigns, such benefits will also be positively felt by other peripheral economies. In addition, such benefits will also help give some much needed credibility to the Euro zone overall policy efforts in dealing with the crisis.

23/8/2012: Mortgages Arrears in Ireland - Q2 2012

At last we have the data for Q2 2012 mortgages arrears in Ireland, and these are ugly. That's right, folks - ugly.

Let's keep in mind: Irish average household size is at 2.73 persons per household as per Census 2011.

Top numbers:

• Total number of outstanding mortgages in the state stood at 761,533 in Q2 2012, down 0.34% q/q and down 2.03% y/y. In the previous quarter (Q1 2012) the rate of mortgages decline was 0.63% q/q and 2.34% y/y. This suggests a slowdown in mortgages repayments (deleveraging) in the economy, despite the Government claims to the economic stabilization (something that would be consistent with accelerating deleveraging).
• Outstanding balances of mortgages are at €111.99 billion in Q2 2012, a decline of 0.62% q/q and 2.69% y/y. Again, compared with Q1 2012, there is a slowdown in deleveraging (-0.70% q/q and -2.82% y/y in Q1 2012).
• Of all mortgages outstanding, 45,165 mortgages or 5.93% (totaling €7.53 billion or 6.73% of all balances) were in arrears less than 90 days. In Q1 2012 the number was 46,284. This is a mew category of reporting and Central Bank deserves credit for continuing to improve data disclosure to the public.
• Of all mortgages outstanding, 17,533 (2.3%) of mortgages were in arrears between 91 and 180 days, with mortgage balance of €3.13 billion (2.79%). Good news, there has been a deecrease q/q in these mortgages - down 3.52% (in Q1 2012 there was a rise of 2.06% in this category) in number of accounts and a drop of 5.73% (against a rise of 1.32% in Q1) in mortgages volumes. Year on year, this category of mortgages arrears is up 11.64 in Q2 2012 which marks a slowdown from 27.5% rise y/y in Q1.
• However, the decline in the 91-180 days category of mortgages in arrears (-640 mortgages q/q) is almost ten-fold smaller than the rise in the arreas 180-days and over category (up 6,261 q/q in Q2). In other words, the decline in mortgages in arrears 91-180 days is explained fully by the rise of mortgages in arrears over 180 days.
• Number of mortgages in arrears in excess of 180 days now stands at a massive 65,698, up 10.53% q/q in Q2 2012 (in Q1 2012 the same rate of increase was 11.89%) and up 64.1% y/y. These mortgages amount to €13.35 billion - which represents a 10.64% q/q increase and a 67.22% increase y/y.
• Using old methodology, total arrears over 90 days now amount to 83,251 mortgages (up 7.24% q/q and 49.3% y/y), with a balance of €16.48 billion (up 7.11% q/q and 52.1% y/y). 
• Thus, currently, 10.93% of all mortgages in Ireland are in arrears 90 days and more, and these amount to 14.72% of total mortgages balances. For comparison, in Q2 2011 these percentages were 7.17% and 9.42% respectively.
• Using newly available data on mortgages in arrears less than 90 days, total number of mortgages in arrears in Ireland is 128,416 (16.86% of all mortgages outstanding) and these amount to €24.01 billion (21.44% of all outstanding balances).
• Now, put the above number in perspective - that is around 350,576 people (actually more, since mortgages arrears are likely to impact younger and larger households over retired and smaller households) in this country who are missing payments on their mortgages.
• In Q2 2012 there were 84,941 restructured mortgages (up 6.56% q/q and 21.63% y/y). The rate of restructuring has declined from Q1 2011 when q/q there was a rise of 7.17% and y/y there was a rise of 26.66%.
• Of restructured mortgages, 47.35% were not in arrears. Percentage of restructured mortgages in arrears has fallen from 56.41% in Q2 2011 and from 48.50% in Q1 2012. Which, of course, means that more an more restructured mortgages are falling back into arrears, implying that the restructuring solutions do not work for at least 53% of mortgages to which they were applied.
• As of the end of Q2 2012, there were total of 169,598 mortgages (22.27% of all mortgages outstanding) that were at risk (in arrears, restructured and not in arrears, and subject to repossessions). This represents (using average household size) 463,003 persons.

Charts to illustrate above trends:

At this stage, there is no point of denying that all restructuring and other 'solutions' deployed by the banks and designed by the Government are not working. The mortgages crisis is raging on. When you look at the third chart above, even using old definition of mortgages at risk (>90 days arrears), the trend up is linear, implying a constant rise in mortgages risk. Even abstracting away from the possible effects of the new insolvencies legislation on mortgages defaults, the trend above suggests that by Q1 2013 we will be close to 150,000 mortgages at risk (using in arrears more than 90 days metric). This would push overall mortgages at risk to beyond 200,000. More than half a million Irish people will be living in households at risk of falling behind on their mortgages repayments. The question I would like to ask of our 'leaders' is "Then, what?"

23/8/2012: More time for Greece is not an asnwer

As Greek PM, Samaras, heads for talks with Angela Merkel this Friday, here's why 2 more years won't work for Greece: link here.

22/8/2012: Charting Russian Reserves rise, and fall, and rise again

A mighty nice chart courtesy of FRED database, showing the recovery in Russian state reserves (ex-gold) following marking down and deficit financing during the crisis.

In 1998-1999 reserves stood at a monthly average of USD8.73 billion, by their peak in 2008 the monthly average was USD507.0 billion. In the first 6 months of 2012 the reserves averaged USD466 billion, which is only 8.1% below their peak year levels. At the crisi trough, the reserves were down to USD368 billion.

22/8/2012: Globe & Mail: The Good, the Bad & the Ugly

My tongue-in-cheek piece for The Globe & Mail on Euro area crisis: here.

20/8/2012: Hungary - a country that can't?..

An interesting blogpost by Professor Steve Hanke on Hungarian economy's adventures in the crisis land.

Here's another look at Hungary (all data is via IMF WEO). Green boxes show ranges of values required for Hungary to effectively converge in economic development with top EU12 states and those that are consistent with long-term sustainability of public finances.

Fron the first chart it is clear that Hungary did well during the period from 1997 through 2006 in terms of real economic growth, but severely underperformed in terms of external balances. In fact, for the period 1995-2017 (incorporating IMF latest forecasts) Hungary operates within its means (in terms of current account balance) in only 4 years.

While current account deficit remained steady at worse than -7.0% of GDP in 1998-2008, little of this relates to investment supports. In fact, current account deficits vastly exceed the portion of the economic investment not financed by savings.

Per chart above, it is also clear that Hungarian investment has declined precipitously, as a share of GDP, from the peak 27.65% in 1998 to 23.54% in 2008 and fell to around 18% from 2012 on. Meanwhile, savings too trended down over the period 1995 through 2017. The economy is becoming less and less capable of generating investment-driven growth (and that is ignoring the issues of credit supply in the banking system etc).

Hungary's Government debt was relatively benign, compared to many european counterparts during the period of 1997-2006. However, the metric used (debt around 60% of GDP) ignores the reality of an economy that is still in catching up with the more advanced European states (including some post-transition economies, such as Czech Republic and Slovenia) in terms of income per capita and other macroeconomic parameters. Such catching up can only be aided by lower debt to GDP ratios and more investment.

In line with external deficits highlighted above, Hungary has run some extremely severe imbalances on both structural government deficit and net government borrowing (ordinary deficit) sides, as shown in the chart below. In terms of government deficit, Hungary was in the red, on average by 3.48% of GDP in the period pre-accession to the EU. Between 2001 and 2007 the deficit averaged massive 6.92% annually, declining to 2.3% of GDP in 2008-2012. The benign level of current deficit (2012 expected deficit of 3% of GDP comes on top of surplus of 3.96% in 2011) is only highlighting the fact that short-term corrections are no substitute for longer-term prudence. Between 1995 and 2012, Hungarian Government was operating within 3% deficit criterion for only 2 years.

Cumulated, the twin current and government deficits from 2000 on through 2012 are severe:

All of this suggests that Hungary suffers (at 80.45% of GDP in 2011) from a classic debt overhang problem exacerbated by the long-term poor performing fiscal deficits and current account dynamics. That these effects should be felt even at the level of debt traditionally considered to be relatively benign (Hungary's 5-year average Government debt through 2012 stands at 78% of GDP compared to 62% for the 5 year period between 2003 and 2007) is probably best explained by the country relatively lower ability to sustain even these levels of debt.