25/2/18: Syria: a Web of VUCA

In his column this week, Tyler Cowen, of Bloomberg View, sums up the VUCA nature of the ongoing conflict in Syria. In fact, his article is more fundamental than that. He paints a coherent picture of how Syria conflict serves as a fertile ground for growth of Black Swan-type tail risks (risks of large scale impact events with low or zero historical predictability).

In simple terms, in Syria, the U.S. and Russia (and their auxiliary proxies) combine three key VUCA factors:

• Ambiguity: represented by the inability to distinguish and delineate clearly the adversarial actors involved in each individual incident: Russian proxies are met with American proxies, amidst a veritable soup of various other actors;
• Uncertainty: represented by lack of clear, stated in advance, and transparently enforced objectives by major actors, most commonly the U.S., but also Russia and Iran;
• Complexity: captured by a complex web of interests, internal-to-Syria and global objectives, etc. 

As Cowen correctly warns, incidents like the alleged Russian proxies-led attack on the U.S. and Kurdish compound can create a potential for a large scale risk materialization or blow-out. Or, put into more academic language,  VUCA environment is self-sustaining: ambiguity, uncertainty and complexity interact to produce a cyclical reinforcement of Volatility (risk). The vicious cycle repeats, amplifying the extent to which VUCA impact (size of the potential forthcoming systemic shock), likelihood (probability of a systemic forthcoming shock), proximity (timing of the systemic shock) and velocity (speed with which the forthcoming shock arrives) rise.


Read Cowen's article in full here: https://www.bloomberg.com/view/articles/2018-02-23/us-s-killing-of-russians-in-syria-is-harbinger-of-more-violence and read these excellent descriptors of how complexity of Syrian conflict is evolving: https://taskandpurpose.com/complexity-syrias-war-catching-us/ and here: http://www.periscopic.com/news/removing-confusion-from-complexity.

14/91/17: Risk, Uncertainty, Political Risks and Markets

My article on the links between political risks, financial returns and economic growth in the MFTimes: http://issuu.com/publicationire/docs/mf_august_2017?e=16572344/51951043 pages 5-7.

20/7/17: U.S. Institutions: the Less Liberal, the More Trusted

In my recent working paper (see http://trueeconomics.blogspot.com/2017/06/27617-millennials-support-for-liberal.html) I presented some evidence of a glacial demographically-aligned shift in the Western (and U.S.) public views of liberal democratic values. Now, another small brick of evidence to add to the roster:

The latest public opinion poll in the U.S. suggests that out of four 'net positively-viewed' institutions of the society, American's prefer coercive and non-democratic (in terms of internal governance - hierarchical and command-based) institutions most: the U.S. Military and the FBI. as well as the U.S. Federal Reserve. Note: the four are U.S. military, the FBI and the Supreme Court and the Fed are all institutions that are not open to influence from external debates and are driven by command-enforcement systems of decision making and/or implementation. Whilst they serve democratic system of the U.S. institutions, they are  subject to severely restricted extent of liberal checks and balances.

Beyond this, considering net-disfavoured institutions, executive powers (less liberty-based) of the White House are less intensively disliked compared to more liberty-based Congress.

27/6/17: Millennials’ Support for Liberal Democracy is Failing

New paper is now available at SSRN: "Millennials’ Support for Liberal Democracy is Failing. An Investor Perspective" (June 27, 2017): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2993535.


Recent evidence shows a worrying trend of declining popular support for the traditional liberal democracy across a range of Western societies. This decline is more pronounced for the younger cohorts of voters. The prevalent theories in political science link this phenomena to a rise in volatility of political and electoral outcomes either induced by the challenges from outside (e.g. Russia and China) or as the result of the aftermath of the recent crises. These views miss a major point: the key drivers for the younger generations’ skepticism toward the liberal democratic values are domestic intergenerational political and socio-economic imbalances that engender the environment of deep (Knightian-like) uncertainty. This distinction – between volatility/risk framework and the deep uncertainty is non-trivial for two reasons: (1) policy and institutional responses to volatility/risk are inconsistent with those necessary to address rising deep uncertainty and may even exacerbate the negative fallout from the ongoing pressures on liberal democratic institutions; and (2) investors cannot rely on traditional risk management approaches to mitigate the effects of deep uncertainty. The risk/volatility framework view of the current political trends can result in amplification of the potential systemic shocks to the markets and to investors through both of these factors simultaneously. Despite touching on a much broader set of issues, this note concludes with a focus on investment strategy that can mitigate the rise of deep political uncertainty for investors.

11/7/16: Russian Strategy Change? Perhaps... and Lets Hope So

A rather interesting analysis from The Moscow Times on the emerging directional change in Russian geopolitical strategy: http://www.themoscowtimes.com/opinion/article/a-modest-deal-vladimir-putins-new-d233tente-op-ed/574322.html.

As someone who consistently stressed the need for both, Russia and the West, to (1) actively seek cooperative resolution to the ongoing process of confrontational politics, and (2) pursue consistent policy of de-escalating relations, with a specific focus on potential sources of risks (e.g. accidental encounters in the international air space or waters), recent change in rhetoric from Moscow is certainly welcome. In time, I suspect, we will see more comprehensive strategy emerging from Kremlin statements, but for now, even less-than-comprehensive statements are a good sign.

As a note of caution, I do not agree with the entire set of the author conclusions. Just highlighting the important nature of change. The degree of risks severity here is highlighted by a range of surveys and public opinion views, here is a snapshot of investors' key concerns:

In this environment, last thing anyone needs is more geopolitical risks.

15/12/15: Russian Outlook for 2016: Slon & Rain

My first column for Russian current affairs magazine Slon is out covering outlook for Russian economy for 2016: https://slon.ru/posts/61120.

I spoke about the topic on Russian TV Channel Dozhd' (Rain): https://tvrain.ru/teleshow/slon_na_dozhde/dollar_71-400099/.

21/2/15: Russian Sovereign Wealth Funds: 2015 drawdowns

In the previous note I covered Moody's downgrade of Russian sovereign debt rating (see http://trueeconomics.blogspot.ie/2015/02/21215-moodys-downgrade-russia-risks-and.html). Now, as promised, a quick note on Russian use of sovereign fund cash reserves (also referenced in the Moody's decision, although Moody's references are somewhat more dated, having been formulated around the end of January).

Back at the end of January, Russia’s sovereign wealth funds amounted to USD160 billion, with the Government primarily taking a historically-set approach (from 2003 onwards) of arms-length interactions with the Funds management. This relative non-interference marked 2014 and is now set to be changed, with the Government looking at using SWFs to provide some support for the investment that has been falling in 2013-2014 period and is likely to fall even further this year.

Fixed investment in Russia fell 2.0% y/y in 2013, and by another 3.7% in 2014. Private investment is likely to fall by double digits in 2015, based on the cost of funding, lack of access to international funding and general recession in the economy. It is likely to stay in negative growth territory through 2016.

Thus, last week, Prime Minister Medvedev signed an executive order deploying up to RUB500 billion from the Reserve Fund. The money will be used, notionally, to cover this year deficits (expected to hit 2% of GDP), thus protecting the state from the need to borrow from the markets. The Fund was originally set up precisely for this purpose - to finance deficits arising during recessionary periods. In other words, this is stabilisation-targeted use of stabilisation funds. The fund is fully accounted for in the total Forex reserves reported by the Central Bank. Latest figures for end of January 2015 showed the fund to have USD85 billion or RUB5,900 billion in its reserves, so this year allocation is a tiny, 8.5% fraction of the total fund. All funds are allocated into liquid, foreign currency-denominated assets.

The second use of SWFs is via the economic support programme that will draw up to RUB550 billion worth of funds in 2015 from the second SWF - the National Welfare Fund (NWF). Part of this funding is earmarked for banks capitalisation, ring fenced explicitly for banks providing funding to large infrastructure investments and lending for the enterprises. The use of the NWF funds is more controversial, because the Fund was set up to provide backing for future pensions liabilities, including statutory old-age pensions. However, the NWF has been used for the economic stimulus purposes before, namely in the 2009 crisis. Currently, NWF holds USD74 billion or RUB5,100 billion worth of assets. Liquid share of these assets, denominated in foreign currencies, is also included in the Central Bank-reported Forex reserves, but long-term allocated illiquid share and ruble-denominated assets are excluded from the CBR reported figures.

Now, per Moody's note issued last night, "The second driver for the downgrade of Russia's government bond rating to Ba1 is the expected further erosion of Russia's fiscal strength and foreign exchange buffers. …Taking at face value the government's plans to proceed with its planned fiscal consolidation for 2015, Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels. …Moreover, under the stress exerted by a shrinking economy, wider budget deficits and continued capital flight -- in part reflecting the impact of the Ukraine crisis on investor and depositor confidence -- and restricted access to international capital markets, Moody's expects that the central bank's and government's FX assets will likely decrease significantly again this year, cutting the sovereign's reserves by more than half compared to their year-end 2014 level of approximately USD330 billion. In a more adverse but not unimaginable scenario, which assumes smaller current account surpluses and substantially larger capital outflows than in Moody's baseline forecast, FX reserves including both government savings funds would be further depleted. While the government might choose to mobilise some form of capital controls to impede the outflow of capital and reserves, such tools are not without consequences. Capital controls, which might include a rationing of retail deposit withdrawals and/or prohibition upon repatriation of foreign investment capital, would weaken the investment climate further and undermine confidence in the banking system."

21/2/15: Moody's Downgrade: Russia Risks and Politics

Moody's downgraded Russian sovereign debt last night from Baa3 to Ba1 with negative outlook. Moody's put Russian ratings on a review back on January 16.

The bases for the downgrade were (quotes from Moody's statement):

1. "The continuing crisis in Ukraine and the recent oil price and exchange rate shocks will further undermine Russia's economic strength and medium-term growth prospects, despite the fiscal and monetary policy responses". In more specific terms, "Russia is expected to experience a deep recession in 2015 and a continued contraction in 2016. The decline in confidence is likely to constrain domestic demand and exacerbate the Russian economy's already chronic underinvestment. It is unlikely that the impact of recent events will be transitory. The crisis in Ukraine continues. While the fall in the oil price and the exchange rate have reversed somewhat since the start of the year, the impact on inflation, confidence and growth is likely to be sustained." As I noted on numerous occasions before, monetary policy environment remains highly challenging. Per Moody's "The monetary authorities face the conflicting objectives of keeping interest rates high enough to restrain the exchange rate and bring down inflation and keeping rates low enough to reinvigorate economic growth and bank solvency."
2. "The government's financial strength will diminish materially as a result of fiscal pressures and the continued erosion of Russia's foreign exchange (FX) reserves in light of ongoing capital outflows and restricted access to international capital markets." I will post a quick note on this matter later today, so stay tuned. Here's Moody's view: "Taking at face value the government's plans to proceed with its planned fiscal consolidation for 2015, Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels. Moody's also expects that widespread demands for fiscal easing are likely to emerge if, as the rating agency projects, the recession persists into 2016. In a scenario in which the government would turn to borrowing in the domestic market to finance at least a share of these deficits, higher spending could result in an increase of the debt-to-GDP ratio to 20% or more."
3. "The risk is rising, although still very low, that the international response to the military conflict in Ukraine triggers a decision by the Russian authorities that directly or indirectly undermines timely payments on external debt service." In other words, we are facing a political risk. Capital controls and debt repayment stops are two key risks here and these were visible for some time now, especially if you have followed my writing on the Russian crisis.

What's the driver for the negative outlook? Uncertainty. Per Moody's: "The negative outlook on the Ba1 rating reflects Moody's view that the balance of economic, financial and political risks in Russia is slanted to the downside, with scenarios incorporating either an escalation of the Ukraine crisis and/or damage caused by recent shocks being greater than in Moody's baseline scenario. Essentially, the probabilities associated with the downside scenarios are higher than those associated with an upside scenario in which the recession is shorter and shallower than Moody's baseline."


Conclusion: an ugly, but predictable move by Moody's. One can say part of it is down to rating agencies activism in trying to establish some sense of credibility post-Global Financial Crisis, whereby getting tougher on ratings is a major objective, and it is well-served by getting tougher on politically softer targets, like Russia. But one can equally argue that the ratings downgrade is consistent with economic environment and some longer-run fundamentals. My view would be is that we are seeing both, with the balance of impetus tilted toward the latter argument.