3/8/17: BRIC Services PMI: July

Having covered BRIC Manufacturing PMIs in the previous post (http://trueeconomics.blogspot.com/2017/08/3817-bric-manufacturing-pmis-july.html), here is the analysis of the Services Sector PMIs.

Brazil Services PMI continued trending below 50.0 mark for the third month in a row, hitting 48.8 in July, after reaching 47.4 in June. While the rate of contraction in the sector slowed down, it remains statistically significant. This puts an end to the hope for a recovery in the sector, with Brazil Services PMIs now posting only two above-50 (nominal, one statistically) readings since October 2014.

Russian Services PMI also moderated in July, although the reading remains statistically above 50.0. July reading of 52.6 signals slower growth than 55.5 reading in June. The Services sector PMIs are now 18 months above 50.0 marker, continuing to confirm relatively sustained and robust (compared to Manufacturing sector) expansion.

China Services PMI remained in the statistical doldrums, posting 51.5 in July gayer 51.6 in June. The indicator has never reached below 50.0 in nominal terms in its history, so 51.5 reading is statistically not significant, given PMIs volatility and positive skew. Overall, this is second consecutive month of PMIs falling below statical significance marker, implying ongoing weakness in the Services economy in China.

India’s Services PMIs followed Manufacturing sector indicator and tanked in July, hitting 45.9 (sharp contraction), having previous posted statistically significant reading for expansion at 53.1 in June. Volatility in India’s Services indicator is striking.

Table and chart below summarise short term movements:

Looking at quarterly comparatives, July was a poor month for Brazil Services sector, with July reading of 48.8 coming in weaker than already poor 49.0 indicator for 2Q 2017. In Brazil’s case, current recession in Services is now reaching into 12th consecutive quarter in nominal terms and into 15ht consecutive quarter in statistical terms. Russia Services PMI also moderated at the start of 3Q 2017 (52.6 in July) having posted average 2Q 2017 PMI of 56.0. Russia Services sector expansion is now into its 6th consecutive quarter (statistically) and seventh consecutive quarter nominally. The same, albeit less pronounced, trend is also evident in China (July PMI at 51.5 against 2Q 2017 PMI of 52.0). India Services PMI was under water in 4Q 2016, followed by weak (zero statistically) growth in 1Q 2017 and somewhat stronger growth in 2Q 2017. The start of 3Q 2017 has been marked by a sharp, statistically significant negative growth signal.

With Global Services PMI hitting 53.7 in July, against 53.8 average for 2Q 2017 and 53.6 average in 1Q 2017, BRIC economies overall are severely underperforming global growth conditions (BRIC Services PMI is now below Global Services PMI in 3 quarters running and this trend is confirmed at the start of 3Q 2017).

3/8/17: BRIC Manufacturing PMIs: July

BRIC PMIs for July 2017 are out, so here are the headline numbers and some analysis. 

Top level summary of monthly readings for BRIC Manufacturing PMIs is provided in the Table below:

Of interest here are:

• Changes in Brazil Manufacturing PMI signalled weakening in the economy in June that was sustained into July. Manufacturing PMI for Brazil has now fallen from 52.0 in May to 50.5 in June and to 50.0 in July. This suggests that any recovery momentum was short lived. 
• Russian Manufacturing PMI, meanwhile, powered up to 52.7 in July from 50.3 in June, rising to the highest level in 6 months. Good news: Russian manufacturing sector has now posted above-50 nominal readings in 12 consecutive months. Less bright news: Russian Manufacturing PMIs have signalled weak rate of recovery in 5 months to July and July reading was not quite as impressive as for the period of November 2016 - January 2017. Nonetheless, if confirmed in August-September, slight acceleration in Manufacturing sector can provide upward support for the economy in 3Q 2017, support that will be critical as to whether the economy will meet Government expectations for ~2% full year economic expansion.
• Chinese manufacturing PMI gained slightly in July (51.1) compared to weak May (49.6) and June (504.), but growth remains weak. Last time Chinese Manufacturing posted PMI statistically above 50.0 (zero growth) marker was January 2013. This flies in the face of official growth figures coming from China.
• India’s Manufacturing PMI fell off the cliff in July (47.9) compered to already weak growth recorded in June (50.9). Over the last 3 months, India’s Manufacturing sector has gone from weak growth, to statistically zero growth to an outright contraction.

Overall, GDP-weighted BRIC Manufacturing PMI stood at extremely weak 50.4 in July 2017, down from equally weak 50.6 in 2Q 2017. In both periods, BRIC Manufacturing sector grossly underperformed Global Manufacturing PMI dynamics (52.7 in July and 52.6 in 2Q 2017). Russia is the only country in the BRIC group with Manufacturing PMI matching Global Manufacturing PMI performance in July. Russian Manufacturing PMI was below Global Manufacturing PMI in 2Q 2017.

Net outrun: BRIC Manufacturing sector currently acts as a drag on global manufacturing growth, with both India and Brazil providing momentum to the downside for the BRIC Manufacturing PMIs.

Global trade protectionism: politics at its worst

To start with, here is a great quote from Jagdish Bhagwati - courtesy of the Cato Institute's Center for Trade Policy Studies:

"[L]abour union lobbies and their political friends have decided that the ideal defence against competition from the poor countries is to raise their cost of production by forcing their standards up, claiming that competition with countries with lower standards is “unfair”. “Free but fair trade” becomes an exercise in insidious protectionism that few recognise as such."
"Obama and Trade: An Alarm Sounds," Financial Times. January 9, 2009.


Lest anyone thought that one party controlling the Congress and the White House is such a handy idea, there is a welcome package for the EU's exporters being prepared by the Democrats.

According to the reports in today's press, President Obama's much-awaited $825bn stimulus package will include a “Buy America” clause - the American Steel First Act. The act will ensure that only US-made steel will be used in $64 billion of federally financed infrastructure projects.

Clearly, Anyone-but-the-Republicans EU leadership is going to see some nasty surprises from the new Administration - if not courtesy of Mr Obama himself, then certainly thanks to the good old protectionist traditional Democrats that Europeans love so much.

The initiative has already secured the House of Representatives Appropriations Committee blessing and is about to trigger a new Steel War with Europe. The EU Commission is already making noises about taking the US to WTO. The US, of course, signed and ratified the WTO's Government Procurement Agreement which requires it to grant fair access to its federally financed projects to all competitors.

If course, some EU states themselves are toying with 'Buy Domestic' types of rescue packages. France, usually the leader of the protectionist pack despite being economically open when it comes to French sales and investments abroad has squeezed in a €6bn aid package for its automakers that includes a commitment for them to purchase on French-made components.

In the UK, plans to give state aid to car makers are also reportedly to include assurances from the comapnies not to use funds outside the country.

A similar €4bn package of aid to Saab and Volvo in Sweden also came with the same strings attached.

And then there is a decision to reintroduce dairy export subsidies by the EU's Agricultural Commissioner, Mariann Fischer Boel. The measure is not only protectionist, but came despite the EU commitment in November 2008 not to introduce new trade barriers in order to allow the troubled Doha Round of global trade talks to be finalised with some face-saving dignity for the WTO.

So maybe in the end Mr Obama is an EU-like President?

Of course, the developing nations are also moving in quickly to shut some of their markets to foreign competition, but this is hardly a reasonable ground for EU and US to start erecting their own trade barriers. History offers a somber reminder: passage of the 1930 Smoot-Hawley Tariff Act in the US triggered a wave of tariff increases across the world. Within a year, average foodstuffs tariffs went up 53% in France, 60% in Austria, 66% in Italy, 75% in Yugoslavia, 80% plus in Czechoslovakia, Germany, Romania and Spain and more than doubled in Bulgaria, Finland and Poland. We all know what that led the world...

Talking up our economy

Today, Brian Cowen has issued a Bertiesque warning to commentators 'talking down Irish economy'. I beg to disagree. Firstly, the problem Ireland is facing is not that some commentators want to uncover the truth, but that our Government is failing to listen to anyone, save for a handful of public sector mandarins and political appointees. Secondly, lest anyone accuses myself of scaremongering, I remind our Taoiseach and his Cabinet that I have publicly put forward a constructive proposal for dealing with the current crisis as far back as in August 2008.

Here are few details:

In August 2008 edition of Business&Finance magazine, I predicted that Ireland will continue its downward trajectory in terms of stock market valuations and economic performance unless the Government were to tackle the issue of public sector overspend and consumer debt. In early October, from the same platform, I re-iterated a call for the Government to get serious with the problem of rising household insolvencies and corporate debt burden. At that time, I provided an outline of a basic plan that I hereby reproduce (some of the modifications to the original plan were featured in my article in Business&Finance in November).

Here is a bold, but a realistic proposal for moving the Government beyond its current position of playing catch up with deteriorating fundamentals. The Exchequer should:

• Announce a 10% reduction across the entire budget and an up to 60% cut on the discretionary non-capital spending under the NDP, generating ca €12-15bn in savings. The cut should include a 100% suspension of all overseas assistance until the time the economy returns to its long-term growth path of ca 2.5-3%.
• Cut, permanently, 10% of the public sector employment (effecting back office staff alone), saving ca €1bnpa after the costs of the measure are factored in.
• Freeze pensions indexation in the public sector for 2008-2015 and make mandatory a 50% contribution to all pensions plans written in the public sector, generating ca €1-2bn in savings.
• Stop the unfunded contributions to the NPRF, saving some €1.5bn per annum.
  

Combining all the savings, the Government should be able to :

• Bring 2009-2010 deficits to within the Eurozone limits; and
• Supply temporary tax refunds of ca €5,000pa per household in 2009-2010 ring-fenced for pensions plans and mortgages funding only.
  

The resulting capital injection of ca €7.5bn pa will be able to:

1. de-leverage the households (amounting, by the end of 2010 to a ca 25% reduction in the total households’ debt), improving consumer sentiment and re-starting housing markets;
2. help recapitalize the banks and improve their loans to capital ratios more efficiently than a debt buy-back, a nationalization, a direct injection of capital from the Exchequer or a debt guarantee.
   

It will result in a sizeable (ca 5% of the entire economy) annual stimulus, without triggering inflationary pressures associated with the Santa-like Government subsidies or consumption incentives.

This proposal implies no burden on the future generations, as the entire stimulus will be paid from the existent fiscal overhang and the set-aside public funds, with the public pensions covered by the contributory schemes.

Lastly, to achieve a morally justifiable and economically stimulative recapitalization of the banks, the plan would require Irish institutions receiving any additional public financing to issue call options on ordinary shares with a strike price set at the date of the deposit and maturity of 5 years. These shares should be distributed to all Irish households on the flat-rate basis.

Thus, assuming the need for additional capital injections of €6-9bn in the Irish financial institutions through 2010 (over and above the €7.5bn pa injected through mortgages repayments and pensions re-capitalizations), Irish households will be in the possession of options with a face value of €4,000-6,000 per household, thus increasing their financial reserves. At the time of maturity, assuming options are in the money, the Exchequer will avail of a special 50% rate of CGT on these particular instruments. Assuming that share prices appreciation of 40% between 2009 and 2014, the CGT returns to the Exchequer will yield ca €1.8bn, ex dividend payments.

Volatility falling?

In a rare piece of good news VIX index measuring (albeit imperfectly) revealed risk assessments in the US markets, has fallen below 40 on the final trading day of the year, for the first time since October 1. The VIX is the Chicago Board Options Exchange Volatility Index shows the market's expectations for volatility over a 30-day period.

As my students in Investment Theory course would know, only human imagination is a limit to the number of ways one can think about (and depict) market volatility. Here are three simple (my favourite criteria for empirical validity) ways of doing this.

Chart 1 plots VIX data since January 1990. This shows a dramatic fall in VIX reading since November highs. But, it also shows the cyclicality of VIX – an approximate 3:5:3 cycle of 3 years rising volatility trend, followed by 4-5 years of elevated ‘flat’ trend, concluding with a 3 years of falling trend. By this pattern, we are not out of the woods. Indeed, we have just finished the 3-year rising trend bit around mid 2008, implying that a long-term elevated volatility period may be still ahead for us.
Chart 2 plots intra-day variation in VIX (High-to-Close, alongside the same logic as semi-variance models of risk pricing). Note the unusually elevated red peaks since ca July 2007. This disputes the common claim that it took some time for credit markets troubles (starting in mid-Summer 2007) to feed through into the markets for real claims (assets with fundamental underpinnings). Once again, the latest moderation in VIX reading may be simply concealing the historically high volatilities in risk perceptions that drive daily markets.

Chart 3 shows three alternative, albeit slightly similar, measures of risk dynamics. Note that up until around mid February 2007, daily deviations in VIX readings measured as ‘High’-to-‘Low’ and ‘High-to-Close’ tracked one another and were roughly in line with the weekly Moving Average in the standard deviation. In other words, while risk itself might have been rising or falling over time, the uncertainty about the future risk levels was much lower and more static prior to the beginning of 2007.
This ‘calm’ was first challenged in February and then finally shattered in late September 2007. Once again, no matter how positive the latest decline in VIX to below 40 may sound, we are not of the woods yet.

Expect:
• More intra-day and intra-week volatility, and
• Less predictability in volatility trend.
2009 seas of financial market are going to be no less choppy than the ‘Perfect Storm’-torn 2008.

A train wreck of Irish economic policy

In managing the ongoing economic crisis, observing Irish Government policy can only be compared to watching a train wreck in slow motion. The banks re-capitalization scheme announced this week is just another example. By ignoring Ireland's impoverished and debt-overloaded consumers and companies, the latest plan will not deliver any real benefits to growth, credit flows or consumer/producer confidence.

One frame…

First, the rails buckle underneath as the Exchequer balance snaps under the weight of reckless public spending. Pop, pop – the fastenings fly off as tax line after tax line comes short. “No worries, we have a plan”, calls out the engineer. Enter the emergency budget – empty of any ideas as to how to mend the path or to lighten the load.

Then, the engine slumps oil-less. Banks hit the friction of bad corporate and household loans. The sparks of private unemployment fly. “All’s fine,” shouts the engineer, “we have insurance”. Emergency banks guarantee follows, but panic engulfs the carriages.

For what seems like an eternity the train pushes on. Dust, gravel and engine parts are shooting in all directions. Business insolvencies double year on year under the weight of the heaviest corporate debt load in the EU. Consumers crumble under the largest debt mountain in the OECD. Homes repossessions are on the rise and retail sales crash. The policy engine spins out of control: income, savings and consumption taxes go up and business rates increase. “The fundamentals are sound,” shout engineers. The rest of the world is selling off Irish shares and assets.

By the end of last week, the index of Irish financial companies shares has fallen 67% relative to the Black Monday of September 29th – the point that triggered the banks guarantee. “This will all end happily,” chirp engineers, “We’ll commission new reports, appoint new committees and issue more emergency responses.”

… to another

Enter this Sunday’s desperate ‘capitalization’ package. This promises to deliver some €10 billion to the banks in a swap for equity. The details, predictably, are sparse. Everyone expects the capital injections to be a copy-cat of those instituted by Germany and the UK – the countries hardly facing the same problems as Ireland. This implies a mixture of private and public funds to be made available to the banks with some token conditions, e.g dividends and management bonuses caps.

In a statement the Department of Finance said the plan will underpin the availability of loans to individuals and businesses.

Ooops. By-passing Ireland’s impoverished consumers and companies, the plan will not deliver any such benefits.

Elsewhere in Europe and the US, similar capitalization schemes have failed to reduce the cost of corporate borrowing or to restart lending to the households. In the UK, a £43 billion capital injection scheme has been in place for almost two months and the supply of consumer and business credit continues to fall - whether due to demand slowdown, lenders withdrawal from the market or both. In the US, massive banks’ capital supports have lowered the mortgage rates, but there is no meaningful increase in new mortgages uptake.

Three reasons for State-to-Banks recapitalization in-effectiveness

First, heavily indebted households are unlikely to take up new credit regardless of the cost. Short of the Government scheme to reduce the household debt or to increase after-tax incomes, no policy will shift consumers out of precautionary savings and into credit markets. So the retail sales will continue falling, businesses will suffer and consumers will keep on heading North for shopping. Our engineers, who two months ago raised VAT and now stubbornly refuse to back-down will see even less VAT revenue in 2009.

Second, heavily indebted Irish businesses can use new credit to either roll-over existent debts, or to finance short-term operational expenses, e.g export transactions. With exception of export credits, any new lending will simply re-arrange the deck chairs on the sinking Titanic of corporate Ireland. None of the new loans will go into capital acquisition, investment or hiring. These activities have stopped not because credit got dear, but because economic demand for goods and services has collapsed.

Third, for the banks, turning recapitalization proceeds into business loans will defeat the entire purpose of the scheme. Assuming re-capitalization is needed because bank’s capital is running too low relative to the size of the impaired or threatened loans, recapitalization must drive up the capital-to-loans ratio. Taking the money and using it to issue more loans will do exactly the opposite.

And this brings us to the issue of costs. The scheme will use the last of the remaining taxpayers’ money – the National Pensions Reserve Fund – to increase capital reserves of the banks. This means the state will no longer have any remaining capacity to inject a meaningful stimulus into the real economy. The consumers will go on cutting spending, business will go on laying off workers and the Exchequer will go on issuing new emergency responses. The more things change…