2/1/2015: Negative Deposit Rates: Swiss Method

The best explanation of the Swiss negative deposit rates intervention I've read so far is here: http://perspectives.pictet.com/2014/12/19/switzerland-the-snb-introduces-negative-interest-rates/ via Pictet Perspectives.

22/12/2014: Economic crisis in Russia is a lose-lose game for all

Here is an unedited version of my article for the Sunday Business Post December 21, 2014 on Russian Currency Crisis.

Less than a month ago, Russian economic data posted surprisingly positive results. Growth was running at 0.7 percent year on year in Q3 2014, more than doubling the consensus forecasts, and only a notch down from 0.8 percent expansion recorded in the second quarter. The exchange rate for the Ruble stood at 56.58 vis-a-vis the Euro and 45.58 vis-a-vis the dollar. Growth outlook for 2015 was a rosy 1.2 percent expansion in GDP.

Visiting Moscow in late November-early December, I was struck by the calm of the city that is known for its chaotic and fast moving business and social life. There were no queues at currency exchanges, no mad dashes for the banks and most certainly no signs of anyone stocking up on goods in fear of a runaway inflation. Business was hurting and economy was slowing down, but there was no panic about it.

Today, after a classic run on its currency experienced on Monday and Tuesday, Russia is amidst a full-blown crisis that is threatening to plunge the economy into a 4.5-4.7 percent contraction in 2015.

On Tuesday, Ruble reached the lows of 79.17 against the dollar and 99.56 against the euro. Two days of subsequent emergency interventions by the Central Bank of Russia and the Finance Ministry, the markets are calmer. Still, through Thursday, Russian currency was down 22.4 percent in value against the Euro and 24.0% against the Dollar compared to Monday open.

Scores of media and financial analysts are evoking the spectre of the 1998 default. This hype is a bit excessive. In 1998, the Russian economy was crippled by a host of problems not present today. Russia was running prolonged and sizeable fiscal deficits, eventually reaching 8 percent of GDP in 1998. So far this year, it is enjoying a fiscal surplus, although banks supports measures announced this week will likely push it into a deficit of 1 percent of GDP. Back in 1998, Government debt stood at just over 100 percent of the national output. This year, it is estimated to be around 15.7 percent. In the decade prior to 1998 default, Russian current account surpluses averaged just 1.13 percent of GDP. Since 2004 they have been running at around 5.6 percent.

This week’s crisis causes rest beyond macroeconomics – in a culmination of the geopolitical and financial risks.

First and foremost, the Russian economy is suffering the consequences of its strong connection to the global energy prices. Over the last 30 days, Brent oil price has declined by 33.4 percent - almost in line with the losses sustained by the Euro/Ruble currencies pair.

Compounding the above, capital outflows have accelerated once again in late November, pushing Central Bank forecast for full year 2014 capital flight to match 2009 crisis levels at USD 103 billion. The timing of the outflows acceleration is ominous. On Tuesday, at the peak of the currency crisis, markets were swelled with false rumors that Rosneft, the largest producer of oil in the country, was looking to offload USD30 billion worth of rubles.

Rosneft story is an indicator of the third real problem faced by Russia in this crisis. Courtesy of Western sanctions, Russian banks and companies have been effectively cut-off from the international funding markets since May this year. As the result, Russian companies and financial institutions have been forced to pay down foreign exchange-denominated debt instead of refinancing it. Rosneft is repaying USD7.6 billion today and the company will need to redeem USD19.5 billion more in 2015. All in, Russian companies and banks are facing some USD101 billion of foreign exchange-denominated debt maturing next year.

The plight of funding Russian economy’s external debt is a telling warning that the crisis for Ruble is not over yet. Excluding debts owed by companies to their off-shored investment vehicles, Russian private sector debt currently stands at a miserly 29 percent of the country GDP. In terms of corporate and banking leverage, Russia is about 7 times less leveraged than your average euro area country. Which puts into perspective the role sanctions are playing in driving down the Russian economy by starving it of credit.

In the longer run, the fallout from the Russian crisis is going to be unpleasant for all parties involved in this geopolitical standoff.

Ruble collapse is pushing misery onto the ordinary Russians, especially the elderly, those living below the poverty line, and those reliant on imported medicines. Meanwhile, power brokers and oligarchs, having stashed their wealth in euros and dollars and spread it across the globe, remain better insulated from the currency devaluations. Ruble collapse is also hurting predominantly smaller businesses which have no access to loans from the Central Bank and cannot raise credit in the dim sum markets of the East.

Ruble devaluation is punishing Ukraine and Moldova - two countries heavily dependent on remittances from migrants working in Russia. Ditto for Tajikistan, Uzbekistan, Armenia and a host of other countries where in recent days domestic currencies fell in line with the Ruble and consumers have started panic buying durable goods in an attempt to escape devaluations.

Beyond that, weaker Ruble is not good for European exporters. Europe exported some EUR120 billion worth of goods and services to Russia in 2013. This year the figure is likely to be around 10 percent lower. Next year, projected decline in Russian imports across the board is expected to hit 15 percent. For imports from Europe this number will be higher, since Russian importers have been aggressively switching in favour of cheaper alternatives from Turkey, China, and some of the former Soviet Union states. All in, Europe is looking at a loss of enough trade over 2014-2015 to put 50-60,000 jobs in exporting sectors into unemployment lines.

If the crisis reignites with the force witnessed this week, capital controls and debt repayment holidays will become inevitable. With them, redemptions of some USD 136 billion worth of private sector debt maturing over the next 18 months will be put into question. That is a lot of risk for Austrian, Dutch, Swedish, French and Italian banks which have an average exposure to Russia to the tune of almost 2.3 percent of their countries’ GDP.

So far, Ireland has been relatively insulated from such risks. In fact, our merchandise exports to Russia  have risen 19.3 percent year on year in the first ten months of 2014 - a truly impressive performance. The reason for this is that, for now, Irish exporters are seen as more neutral, more willing to engage with their Russian counterparts than our competitors in some other European countries. Another reason is that our sales to Russia, small as they might be, are heavily geared toward SME exporters.

No matter what London and Washington politicians say, economic crisis in Russia is a lose-lose game for all.

21/10/2013: Sovereign Debt & Banking Crises: Emerging Markets Evidence

Recent (March 2013) CEPR Discussion Paper No. 9369 by Sylvester C. W. Eijffinger and Bilge Karataş, titled "Three Sisters: The Interlinkage between Sovereign Debt, Currency and Banking Crises" argues that "the sovereign debt default and the linkages from banking and currency crisis have been rarely explored in the crisis literature." The study attempted "to dive into this unexplored area by applying panel data binary choice model on a sample with 20 emerging countries having monthly observations for the years between 1985 and 2007. The non-linear linkages from currency and banking crises to sovereign defaults are explored by using the interactions of these crises with international illiquidity, appreciated real exchange rates and real international monetary policy rates."

The sample is clearly not applicable directly to the advanced economies, such as the euro area, but the findings still remain interesting.

"It is discovered that currency, banking and debt crises tend to occur simultaneously [an increase in the indebtedness of the public sector, overvalued exchange rates and financial as well as political riskiness of a country plays a role in predicting sovereign default].

"Prior occurrence of a currency crisis increases the sovereign default probability through appreciated real exchange rates, and in countries with high short-term indebtedness the occurrence of banking crisis raises the probability of a debt crisis."


Source: www.cepr.org/pubs/dps/DP9369.asp