17/5/15: Two Asias and the U.S. European Incentives

If you want to see the context to the ongoing geopolitical re-distribution of power that is threatening the world order, do not look at the margins of the European realm, like Ukraine. Look at Asia.

Here is an excellent discourse that supports the thesis of the emergence of two Asia:

• Asia dominated (already) economically by China; and
• Asia dominated (for now) military-wise and geopolitically by the U.S.

Read the full text here: http://belfercenter.ksg.harvard.edu/files/Summary%20Report%20US-China%2021.pdf and a summary here: http://www.businessinsider.com/major-change-in-world-order-china-us-economy-2015-5.

Europe has already decoupled with the U.S. on the issue of Chinese-led Asian Infrastructure Investment Bank, while BRICS have decoupled from the U.S. on a vast range of initiatives. But European signals of willingness to engage with the new Asia are going to continue being half-hearted, principally because of the second bullet point above - economic cooperation will not resolve the growing tension on geopolitical stage. Sooner or later, the U.S. dominance in Asia Pacific will be weakened to the point of the Western block playing a second (albeit not insignificant, by any means) role.

There are two levers for retaining direct and active links to the Asia Pacific centre of power that are currently available to Europe: India and Russia. Alas, both are lost to Europeans for now, one for the reason of perpetual neglect and the other for the reason of perpetual antagonisation.

Oh, and one last piece of 'food for thought' breakfast: as the U.S. is being squeezed in Asia Pacific, is it more or less likely that the U.S. will need to amplify cohesion of its allies around the Atlantic? And if you think the answer to this question is 'more likely' (as I do), what other means can the U.S. find to doing so other than by playing centuries old angsts across EU's Eastern borders? 

6/5/15: IMF to European Life Insurers: Japanification Cometh

Life Insurance business is the out-of-sight type of the sector that few notice... until it is too late. So here is an early warning from the IMF (not known for early warnings).

Core point is: we are in a world of Japan - persistently low, extremely low interest rates. Which means that insurance companies with long-dated contracts face the challenge of liabilities exceeding assets at some point in time. The longer the duration of low rates, the greater is the risk of a system-wide insolvency.

So insurance industry took some stress tests recently. And passed. except the stress tested was not enough to match the current reality:

Oops...

22/4/15: Europe is Japanified

Europe has been Japanified, already, for some years now, including in terms of expectations forward...

Source: Author own calculations based on data from the IMF WEO database, April 2015

End of arguments...

18/2/15: IMF Package for Ukraine: Some Pesky Macros

Ukraine package of funding from the IMF and other lenders remains still largely unspecified, but it is worth recapping what we do know and what we don't.

Total package is USD40 billion. Of which, USD17.5 billion will come from the IMF and USD22.5 billion will come from the EU. The US seemed to have avoided being drawn into the financial singularity they helped (directly or not) to create.

We have no idea as to the distribution of the USD22.5 billion across the individual EU states, but it is pretty safe to assume that countries like Greece won't be too keen contributing. Cyprus probably as well. Ireland, Portugal, Spain, Italy - all struggling with debts of their own also need this new 'commitment' like a hole in the head. Belgium might cheerfully pony up (with distinctly Belgian cheer that is genuinely overwhelming to those in Belgium). But what about the countries like the Baltics and those of the Southern EU? Does Bulgaria have spare hundreds of million floating around? Hungary clearly can't expect much of good will from Kiev, given its tango with Moscow, so it is not exactly likely to cheer on the funding plans… Who will? Austria and Germany and France, though France is never too keen on parting with cash, unless it gets more cash in return through some other doors. In Poland, farmers are protesting about EUR100 million that the country lent to Ukraine. Wait till they get the bill for their share of the USD22.5 billion coming due.

Recall that in April 2014, IMF has already provided USD17 billion to Ukraine and has paid up USD4.5 billion to-date. In addition, Ukraine received USD2 billion in credit guarantees (not even funds) from the US, EUR1.8 billion in funding from the EU and another EUR1.6 billion in pre-April loans from the same source. Germany sent bilateral EUR500 million and Poland sent EUR100 million, with Japan lending USD300 million.

Here's a kicker. With all this 'help' Ukrainian debt/GDP ratio is racing beyond sustainability bounds. Under pre-February 'deal' scenario, IMF expected Ukrainian debt to peak at USD109 billion in 2017. Now, with the new 'deal' we are looking at debt (assuming no write down in a major restructuring) reaching for USD149 billion through 2018 and continuing to head North from there.

An added problem is the exchange rate which determines both the debt/GDP ratio and the debt burden.

Charts below show the absolute level of external debt (in current USD billions) and the debt/GDP ratios under the new 'deal' as opposed to previous programme. The second chart also shows the effects of further devaluation in Hryvna against the USD on debt/GDP ratios. It is worth noting that the IMF current assumption on Hryvna/USD is for 2014 rate of 11.30 and for 2015 of 12.91. Both are utterly unrealistic, given where Hryvna is trading now - at close to 26 to USD. (Note, just for comparative purposes, if Ruble were to hit the rates of decline that Hryvna has experienced between January 2014 and now, it would be trading at RUB/USD87, not RUB/USD61.20. Yet, all of us heard in the mainstream media about Ruble crisis, but there is virtually no reporting of the Hryvna crisis).

Now, keep in mind the latest macro figures from Ukraine are horrific.

Q3 2014 final GDP print came in at a y/y drop of 5.3%, accelerating final GDP decline of 5.1% in Q2 2014. Now, we know that things went even worse in Q4 2014, with some analysts (e.g. Danske) forecasting a decline in GDP of 14% y/y in Q4 2014. 2015 is expected to be a 'walk in the park' compared to that with FY projected GDP drop of around 8.5% for a third straight year!

Country Forex ratings are down at CCC- with negative outlook (S&P). These are a couple of months old. Still, no one in the rantings agencies is rushing to deal with any new data to revise these. Russia, for comparison, is rated BB+ with negative outlook and has been hammered by downgrades by the agencies seemingly racing to join that coveted 'Get Vlad!' club. Is kicking the Russian economy just a plat du jour when the agencies are trying to prove objectivity in analysis after all those ABS/MBS misfires of the last 15 years?

Also, note, the above debt figures, bad as they might be, are assuming that Ukraine's USD3 billion debt to Russia is repaid when it matures in September 2015. So far, Russia showed no indication it is willing to restructure this debt. But this debt alone is now (coupon attached) ca 50% of the entire Forex reserves held by Ukraine that amount to USD6.5 billion. Which means it will possibly have to be extended - raising the above debt profiles even higher. Or IMF dosh will have to go to pay it down. Assuming there is IMF dosh… September is a far, far away.

Meanwhile, you never hear much about Ukrainian external debt redemptions (aside from Government ones), while Russian debt redemptions (backed by ca USD370 billion worth of reserves) are at the forefront of the 'default' rumour mill. Ukrainian official forex reserves shrunk by roughly 62% in 14 months from January 2014. Russian ones are down 28.3% over the same period. But, you read of a reserves crisis in Russia, whilst you never hear much about the reserves crisis in Ukraine.

Inflation is now hitting 28.5% in January - double the Russian rate. And that is before full increases in energy prices are factored in per IMF 'reforms'. Ukraine, so far has gone through roughly 1/5 to 1/4 of these in 2014. More to come.

The point of the above comparatives between Russian and Ukrainian economies is not to argue that Russia is in an easy spot (it is not - there are structural and crisis-linked problems all over the shop), nor to argue that Ukrainian situation is somehow altering the geopolitical crisis developments in favour of Russia (it does not: Ukraine needs peace and respect for its territorial integrity and democracy, with or without economic reforms). The point is that the situation in the Ukrainian economy is so grave, that lending Kiev money cannot be an answer to the problems of stabilising the economy and getting economic recovery on a sustainable footing.

With all of this, the IMF 'plan' begs two questions:

1. Least important: Where's the European money coming from?
2. More important: Why would anyone lend funds to a country with fundamentals that make Greece look like Norway?
3. Most important: How on earth can this be a sustainable package for the country that really needs at least 50% of the total funding in the form of grants, not loans? That needs real investment, not debt? That needs serious reconstruction and such deep reforms, it should reasonably be given a decade to put them in place, not 4 years that IMF is prepared to hold off on repayment of debts owed to it under the new programme?

Note: here is the debt/GDP chart adjusting for the latest current and forward (12 months) exchange rates under the same scenarios as above, as opposed to the IMF dreamt up 2014 and 2015 estimates from back October 2014:

Do note in the above - declines in debt/GDP ratio in 2016-2018 are simply a technical carry over from the IMF assumptions on growth and exchange rates. Not a 'hard' forecast.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

28/7/2014: Double Down or Stay Course in Ukraine: the Only Rational Alternatives for Moscow?

The latest reports from the U.S. strongly suggest that Russia is perceived as an un-yielding adversary in Ukraine and that Moscow is about to 'double-down' on its gambit in Ukraine (see here).

The point is that if so, then why and then what?

Why? Russia has currently no exit strategy from the conflict in Ukraine. Forcing complete and total closure of the separatists operations is

1. Infeasible for Moscow (the separatists are not directly controlled troops that can be withdrawn on orders and indications are, they are not all too well coordinated and organised to be following any orders);
2. Were it even theoretically feasible, will be immediately visible to the external observers. Note that, for Moscow, (1) means political benefits of such an action will not be immediately apparent, while (2) means political costs of such an action will materialise overnight.
3. As sanctions escalate, the marginal returns of domestic political support become more important, since external economic benefits from cooperation vanish, but marginal costs remain (see below).

On marginal external benefits: it is absolutely uncertain what exact conditions Russia must fulfil to completely reverse the sanctions: is it

• (a) compel the rebels to surrender unconditionally to Kiev troops? 
• (b) compel them to surrender to either official troops or pro-Kiev militias, unconditionally? 
• (c) compel them to surrender conditionally - without any conditions set and without any mechanism to enforce these in place? 
• (d) compel them to declare a ceasefire - without any conditions set and without any guarantees of enforcement by the opposite side? 
• (e) compel the separatists to engage in peace talks - not on offer by Kiev? 
• (f) compel the separatists to stand down - in some fashion - and enter into negotiations with Kiev on Crimea? 
• (g) Is Crimea at all on the table? and so on...

On marginal costs: the costs of sanctions are tied to Russia delivering some sort of compliance with Western demands. Can someone, please, point to me a website where these demands are listed in full and the states that imposed sanctions have signed off on a pledge that once these conditions are satisfied, sanctions will be lifted?

Thus, in simple terms, current Western position leaves little room for Moscow not to double down in Ukraine. The only other viable alternative for Moscow currently is not to escalate. De-escalation, as much as I would like to see it take place, is not within rational choice alternatives. The core reason for this is that when one constantly increasing pressure in forcing their opponent into the corner without providing a feasible exit route for de-escalation, the opponent's rationally preferred response, at certain point in time, becomes to strike back and double down.

Update: interestingly, Reuters editorial today (29/7/2014: http://www.reuters.com/article/2014/07/29/us-ukraine-crisis-putin-analysis-idUSKBN0FY1AC20140729?feedType=RSS&feedName=topNews&utm_source=twitter) provides very similar lines of argument on costs and incentives for Moscow to de-escalate the situation in Eastern Ukraine.