9/8/2012: Rip-off Ireland roars again in July

Latest consumer price indices are out for Ireland. Headline number for annual comparatives is moderate inflation at 2.0% in HICP metric and 1.6% on CPI metric. M/m we have deflation.

Alas, the headlines do not tell the whole story. Much is revealed in the following three charts which, in summary, show that most of inflation, including double-digit rampant inflation, is concentrated in state-controlled or state-set prices (marked in red).

You can see that even when it comes to energy, state-controlled prices (e.g. electricity and natural gas) are ahead of inflation driven by virtually identical underlying oil and gas prices (other hydrocarbons-linked fuels).

The above, of course is consistent with the State policies that have prioritized extraction of rents from the private economy in order to close fiscal gap. The State is doing this even though Irish Government is aware that we face a deleveraging crisis among our households and companies. In other words, prioritization of the policy is clear - skin consumers to save the Exchequer and to hell with households barely capable of making ends meet.

Don't think that this is not a prescription for an economic disaster. Killing off private economy to sustain public sector's lack of real reforms as well as to sustain exceptionally costly measures to underwrite Irish financial sector meltdown is not a good thing to do. But, hey, 'international investors' seem to approve.

8/8/2012: Updating 2012-2017 forecasts for Russia

Updating my outlook for Russian economy:

First a table summarizing my outlook and IMF forecasts for key macro variables (note: IMF forecasts are as of July 2012, updating WEO database from April 2012).

Second, two significant trends that will dominate Russian macroeconomic themes in near- and medium-term future:

Both charts above are based on IMF data and projections.

The key to both is understanding that the underlying capital dynamics suggest strong capital investment contribution to the GDP and that much of this will be driven by the private sector. This implies strong growth potential in core capital equipment, construction and manufacturing sectors.

However, my estimates of public investment are above those for the IMF, based on two factors:

1. Last Presidential elections have been dominated by the rhetoric concerning modernization and re-structuring of key Russian sectors and the economy overall. Coupled with accelerating depreciation of infrastructure stocks, this suggests elevated public investment in years to come.
2. Recent portests against the Government have clearly been met with a complex response that includes strong recognition by Moscow that accelerated development of the quality-of-life infrastructure and structural reforms in the economy cannot be postponed. This too suggests that the Federal authorities will likely accelerate public investment.

As the result, my projections for private investment remain in-line with those by the IMF, but public investment projections are likely to be ahead of those by the IMF by some 1-1.5% per annum in 2013-2014, rising to 2% over IMF forecast post-2015.

7/8/2012: Once forgotten Growth & Jobs Plan

So, by now we all have forgotten that little bit of June-July newsflow that promised a Compact for Growth to help the EU recover from the euro area-induced depression. And for a good reason - whole thing was a complete fudge. The problem is - this was supposed to be the second half of the EU policy equation. If the entire half of that equation is really a pure fake, what confidence can we have in the validity or sustainability of all other euro area commitments delivered at the last summit of June?

Answer - none.

Now, here's the reminder of the June 'growth fudge'. Alongside the euro area council, the European Commission singled out the European Investment Bank as the core instrument for stimulus measures - which in reality, given EU Commission's total lack of economic policy imagination amounts to public works and infrastructure investments. On July 31, the EU Commission issued a paper covering EU construction sector and calling for the sector to become the core driver of its grandiose scheme to kick-start the euro area economies. Let's keep in mind - the construction sector accounts for just about 10% of total GDP in the euro area, while being responsible for the lion's share of total losses in the euro area banking sector and for the majority of debts in the private sector that currently hold the economies of the euro area hostage.

Back on June 30th, the EU agreed a 'new' stimulus package worth €120 billion - the Growth and Jobs Pact. This 'new' measure, of course consisted of €55 billion of already allocated in the budget, but will be diverted from such worth-while activities as building EU's 'social(ist) / green / nano / smart / knowledge-filled economy' to EU's 'bricks-and-mortar economy'. Of the remaining €60 billion, only €10 billion will come from actual funds, which will be 'leveraged' by EIB (read: more debt) to raise up to €60 billion in funding which the EIB can then lend out to the 'struggling' economies for the purpose of building 'stuff'. There's a problem, Roger, as some would say. Last year, EIB has managed to lend out just €61 billion on the foot of raising €76 billion. In other words, apparently, EIB sees not enough worthwhile investment opportunities to allocate funds it already has. Back in 2010, EIB lent out €72 billion. But with the EU Commission plans, the bank should simply double its lending overnight. 

Despite the fact that by EIB's own admission (see annual report) the levels of lending in 2010 were 'exceptional' and the bank would like to return back to 'normal' lending volumes.

Recap the above: EIB is already lending at 'exceptional' levels and would like to scale this lending back, and EIB would have to double its lending capacity to deliver on EU Commission plan.

Now, what can possibly go wrong with this?

7/8/2012: Real-time evidence on Irish lending bubble collapse

A revealing table from the danske Bank H1 2012 results which hardly needs much of a commentary:

Impairments:

• Northern Ireland 3.5% of lending
• Banking Activities Ireland (non-toxic stuff) 4.16%
• Non-core Ireland (toxic stuff) 18.67%
• Total Banking Activities 0.80
• banking activities Denmark, Finland, Sweden, Norway from 0.17% to 0.47%

And that's about all you need to know. 

But in case you want more - the report is available here.

Oh, and few more revealing tables:

Now, in the above, non-core (toxic) stuff from Ireland is accounting for 72.5% of all charges taken. Nicely done!

6/8/2012: Financial Crises, Recessions and Government Debt

Another interesting chart from The Great Leveraging, by Alan M. Taylor, CEPR DP 9082. This one shows “Excess” Credit Growth (in other words the extent of credit contraction during the crisis) and the Paths of Real GDP in Normal (blue line) and Financial Recession (red line) Contingent on Initial Public Debt Levels.

Here's Taylor's own explanation: Figure 12 from work in progress (Jorda, Schularick, and Taylor, forthcoming) studies the impact of a similar "marginal treatment" [shock of 1% per annum extra loan to GDP growth during the expansion prior to the crisis over an above normal long run levels of growth - and recall that in Ireland's case this rate was probably 3-5 times the shock considered by Jorda et al], subject to starting Government debt/GDP ratio condition (taken as 0% of GDP to 100% of GDP). The central forecast lines - solid lines - provide for assumed 50% of GDP starting assumption for public debt to GDP ratio.

"First look at normal recessions (blue dashed line, dark shaded fan). Extra credit growth in the prior expansion is correlated with mild drag in the recession, say 50-75bps in the central case, but the effect is small, and does not vary all that much when we condition on public debt to GDP levels (the dark fan is not that wide). Now look at financial crisis recessions (red solid line, light shaded fan). Extra credit growth in the prior expansion is correlated with much larger drag, almost twice as large at 100-150bps, and the impact is very sensitive to public debt to GDP levels going in (the light fan is very wide). At public debt to GDP levels near 100% a sort of tailspin emerges after a financial crisis, and the rate of growth craters down from the reference levels by 400bps at the end of the window. Recall, effects in this chart are shown as non-cumulative."

This is serious stuff, folks. In effect the chart above shows that, had Ireland entered the crisis with, say 80% Government debt/GDP ratio, we would have been losing some 2.03% percent on average annually over 6 years. Funny thing - we are, so far on track to exceed this number.

Many say we had a very enviable, low Government debt to GDP ratio at the onset of the crisis - officially - at 44.23% in 2008. Alas, that is platitudinal bull when it comes to hard reality. The problem for the argument involving the 44% figure above is that starting with 2008, Ireland promptly loaded onto the shoulders of the Exchequer massive banks debts, which have pushed Irish Government liabilities up by at least €67 billion, or well above 90% of GDP. Not all of this was taken as debt (NPRF funds) and not all of this was taken as immediate debt (with banks recaps running into 2011), but as far as resources available to combat the crisis go [something that low Government debt at the onset of the crisis should have allowed], banks resolution measures exerted direct drag on Irish Exchequer capacity to use low initial debt levels to fund transition out of the crisis. In other words, as the real data and comparison of it to Taylor's results show, the idea of our low initial starting debt levels being a boom to our situation is bollocks.

Thus, in terms of the chart above, we are closer to 80-90% starting point for debt/GDP ratio for the onset of the crisis period (thanks to Brian Cowen's Government efforts). Which implies that over the 6 years horizon of the crisis, we should expect a cumulative decline in the economy GDP of ca 12%. The fact that over the last 5 years we have seen our GDP declining by 9.52% (using IMF data and 2012 forecast) means only one thing: more pain is yet to come.

6/82012: A Spooky Chart of Decade?

A spooky chart of decade? Why, this one of course:

The chart comes from The Great Leveraging, by Alan M. Taylor, CEPR DP 9082.

Yes, folks, the upward path in the red line - the dependency ratio for more developed regions - is scary enough. Fair play. Although we all knew it. The really monstrous bit is the green line rise from 2030 on and the relative flattening of its decline from 2015 onward. Why is it "monstrous"? Because until recently, immigration into the advanced economies from developing economies was taken as a given. Now, not so much anymore. So, as the dolphins sign in my favorite film: "So long & Thanks for all the fish / So sad that it should come to this / We tried to warn you all but oh dear..." Never say we haven't told you (Europeans) that abandoning family for the sake of social benefits and improved consumption of holidays is not a good idea, but it is even dafter when one thinks that the sources of cheap labour might just run out pretty soon... in and around 2010-2025...

6/8/2012: Russian reforms: Atrophy or Revolution?

Journal of Democracy has 5 articles covering various aspects of the political grass-roots transformations undergoing in Russia (link here):


In "Putinism Under Siege: Implosion, Atrophy, or Revolution?", Lilia Shevtsova argues that the "Putin's regime is clearly now in decline, but it is unclear whether the death knell has sounded for the "Russian System" - a combination of personal rule, the merger of power and assets, and a self-perpetuating stalinist-militarist model. One can conclude, however, that the Russian system cannot be reformed from the top and that real transformation will come only through pressure from citizens."

I am not so sure, this wishful thinking - ranging from rather over-reaching definition of the "Russian System" (which does include the first two of the features outlined in the article, yet hardly resembles a stalinist-militarist model at all) to nostalgia for some sort of a populist, bottom-up transformation (which never happened in the history of Russia before, and given the dire quality of opposition is not about to happen either) - is either a realistic assessment of the near-term (predictable or forecastable) future or a desired path to transformation.

But the article does point to some interesting changes in social dynamics that have led to recent protests and are exposing the dire need for modernization and reforms in the system as well as the fact that since 2006 Russian leadership has had an awfully hard time in attempting to deliver any real change on core political and social changes:


"Discontent with Putin’s regime among educated urbanites has been building for some time as people have witnessed the cynicism, brazen corruption, official high-handedness, and general stasis on display in their government. By the last part of Putin’s second term (between 2006 and 2008), the foundations of his implicit deal with the country were starting to erode. The most active and dynamic sectors of society wanted more than the Kremlin’s offer of stability based on looking to the past and staying within the narrow bounds of old myths about Russia and the world. People began to tire of the notion
that they should be content so long as the authorities let them make a living in return for staying out of politics and recognizing the authorities as having the final say on questions of property ownership, making corruption an essential lubricant when frictions appeared."

"But there inevitably came a moment when Putin’s formula for “social peace” no longer satisfied much of the populace. Too many had come to see that this pact could guarantee them neither opportunity nor prosperity nor even basic security. Moreover, Putin lacked any sense of the kinds of social improvements that might give young people a leg-up in life and a chance to better themselves. The financial and economic crisis of 2008—and the way that Putin and his team reacted to it by guarding their own wealth and that of the oligarchs close to them—cast into especially high relief the flaws in Putin’s model."

So far - plausible, albeit over-rhetoricized account.

The article real failings are in the projections for the Putin 2.0 and gradualist reforms paths, which, the author feels, cannot deliver significant enough change. At this stage, the arguments are purely speculative, based on "why didn't Putin do so before?" reasoning which ignores both the core objectives of pre-2006 path (consolidation of power and stabilization of fragmented institutions) as well as the need for transition to Putin 2.0 regime.

Again, on has to read the entire article in the context of attempting to remove over-extending rhetoric from the fact.

"The authorities’ tactical maneuvers and the myths spread by Kremlin propagandists can no longer stave off a crisis that has already begun. [In my view, this is correct, albeit the word 'crisis' is hardly properly descriptive of current events - the word 'pressure' comes to mind as more apt]. The alleged adaptability of the “Russian system” has been exposed as an illusion—cosmetic changes can no longer hide a more fundamental rigidity. The system guarantees Russians neither personal security, nor
economic well-being, nor a sense of civic dignity. The system works only to satisfy entrenched interest groups at the expense of society at large; the “golden parachutes” that the elites maintain in the form of
assets stored in the West prove that even they do not believe in the sustainability of the current political order. [Well put, in my view... but not warranting subsequent:] The paradox is that propping
up the status quo is speeding up the system’s decline, but attempts to update this status quo without liquidating its basis (personalized power) threaten to cause system breakdown."

In my opinion, the status quo is degenerative. However, change of the status quo requires a long period of building effective, functional democratic opposition. Not a 'personal cult 2 displacing a personal cult 1' system that is currently the only feasible alternative were another equivalent to Putin found somewhere. This process can only be carried out with simultaneous co-existence of the current consolidated regime and constant pressure on this regime to reform. The recent protests have shown this much: there is no alternative to Putin 2.0 transformation for the embryonic democratic forces - which have offered no real policies alternative or leadership options to the current regime, and for the regime itself - which cannot be assured of normal and functional transition of power. In other words, Russia currently has no alternative to the gradualism in transformation. To the author, this means that neither transformation, nor gradualist approach to it are feasible. To me it means that both are inevitable in the long run.

In other words - it is neither Atrophy, nor Revolution that await Russia in the near term future. It is a gradual re-shaping of the Kremlin rule accompanied by the maturing of the democratic alternatives. We better brace ourselves for a much longer term process than the ones we experienced in Russia since 1988. And that is a good news.

I will be blogging on the remaining articles in the issue in time, so stay tuned.

4/8/2012: IMF Article IV assessment of Russia

Latest IMF Article IV paper for Russia was published this week. The link is here.

A number of points worth highlighting:

1. "The current account has strengthened in 2011 aided by high oil prices, but net capital outflows persist, broadly mirroring the current account surplus." In effect, this is continued worrying trend, although one has to recognize that some of the outflows get recycled back into Russian investment via off-shore companies. Nonetheless, the Government efforts to-date to reduce outflows have been unsuccessful. While no one expects capital controls, it is likely that to lower incentives to ship capital out of Russia, absent deep and effective reforms of the legal protection for investors, Russian authorities will need to raise internal interest rates and strengthen the ruble. These measures will, however, reduce growth capacity in the economy.
2. "Following two years of stagnation, credit growth rebounded strongly in 2011. This partly reflected a switch by the corporate sector from external to domestic funding. Consumer credit also grew strongly. On the credit supply side, improving bank balance sheets (with declining nonperforming loan ratios and improving profitability) and funding conditions (reflecting solid deposit growth and the Central Bank of Russia’s liquidity provision) allowed for the expansion of lending." In other words, there is increased stability within the internal financial system. While the process of weeding-out weaker banks is ongoing, this is now organic, rather than disruptive as in the earlier stages of the global financial crisis. Expect no significant adverse surprises in the sector, as consistent with rating agencies position on Russian banks.
3. "Fiscal policy tightened in 2011, but it remains procyclical. The federal non-oil deficit declined from 12.7 percent of GDP in 2010 to 9.8 percent of GDP in 2011. This improvement was due to both non-oil revenue overperformance and expenditure under-execution. Some of the windfall oil revenues from 2011 were deposited in the Reserve Fund in early 2012. However, the 2012 budget implies an increase in the federal non-oil deficit of about 1 percent of GDP." This is consistent with the policy stance announced during the last Presidential elections and is a short-term positive for the economy that is still recovering from the capex slowdown. We have to keep in mind that Russia will have to undergo twin spikes in demand for capital in the next decade or so. The first one will be driven by rapidly accelerating depreciation of the core capital stock - with replacement rates on capital only starting to catch up with amortization and depreciation since 2003-2004. The second one will be driven by the need to lift up overall productivity in the industrial and manufacturing sectors. Parts of this will have to be financed off the private sector investment pools, but parts will have to come from the state coffers.
4. In line with (3) above and also noting that the Central Bank has put on hold further tightening of the monetary policy during the second half of 2011, IMF advised the CB to continue tightening monetary policy. Again, in my view this puts a clear contradiction into the policy mix. Federal Government objective is to push through aggressive investment and modernization programmes over the next few years. This can be aided on supply of capital side by raising rates of return, including by strengthening the ruble. Alas, the demand side will suffer. As will exports. On the positive side, imports of capital equipment will be cheaper, but in the long run, this will also mean fewer imports substitutes emerging in the process of modernization. In other words, Russian monetary, fiscal and development policies are now somewhat out of synch, but they can become even more so, should Russia listen to the IMF advice. 

4/8/2012: Links to my analysis of ECB's policy shift

My thoughts on Mario Draghi's quiet coup are on FTAlphaville (here) and in The Globe & Mail (here). BusinessInsider also picks on my comments (here).

4/8/2012: Business Confidence in Ireland: KBC/ICA v PMI

As promised in the previous post covering the Services PMIs, I wanted to provide some analysis of confidence survey component of the PMIs. This is in light of this week's absolutely bizarre Business Confidence Survey report from KBC/ICA covered briefly here. The reason for why I am giving this survey so much attention is a simple one: the survey authors, in particular KBC, should have done their basic homework before they released the results. This homework would have entailed linking current activity to future business expectations to find out the size of the bias in the later induced by the former.

Here's the core point: businesses (not only in Ireland) tend to report upbeat expectations compared to current activity. And they tend to do so on average - independent of the current conditions. In addition, their expectations of the future are driven by the present conditions, which also implies systemic biases. To see this, simply link current activity to future expectations:

Not to induce any judgement on causality direction - the above pretty clearly shows that on average, expectations are more upbeat than actual activity: a 1 point change current activity is associated, in Irish services firms case, with 14.6 points higher expectations. In other words, we can have a tanking economic activity consistent with deep recession (as signaled by current activity PMI of, say 40) and yet business expectations on average will be reading 54.9 - a robust expansion.

Run through these numbers:

• Since January 2008, Confidence reading for PMI averaged 60.2 - a massively 'upbeat' indication taken on its own. Meanwhile, actual PMI reading averaged 46.8 - a recessionary level reading for the Services sector.
• In last 6 months, actual PMI averaged 50.8, Confidence for the 6 months period through January 2012 is 60.7.

Funny thing, this Confidence survey data is...  

3/8/2012: Irish Services PMI: Disappointing July

So following cracking Manufacturing PMI performance in July (see posts here , here and here on the subject), it was only predictable (based on all indicators relating to the sector activity) that Services PMI will put a boot into our hopes for growth. In that, the PMIs did not deviate from forecast.

Irish Services activity continued to decline in July, with headline PMI for Business Activity falling to 49.1 from 49.4 in June. This marks third consecutive month of sector activity below 50 reading. 12mo MA is now at 50.7, well ahead of the current reading. 3mo average through July is at 49.2 - signaling mild contraction, previous 3mo average through April is at 52.5. In 2011 3mo average for the same period was 51.5 and in 2010 it was 54.5. Not good dynamics for 2012 since May.

New Business activity also slowed down to 49.5 from barely expansionary 50.3 in June. 12mo MA is at 50.2 - effectively showing zero growth, while 3mo average through July is at 49.8 (ditto, but to the downside risk) and this contrasts with relatively robust 52.8 3mo average through April 2012.

Looking at the snapshot of the recent activity clearly shows lack of any breakout momentum in the series from the flat growth trend established around Q4 2010.

Other sub-series were all over the place.

• Employment tanked to 48.3 from already abysmal 49.2 in June. This is not surprising, as the sector has been signaling employment losses pretty much uninterrupted since the beginning of the crisis. 12mo MA is now at 48.1.
• Output prices continued to contract at 44.2 from 44.6 in June, while input costs rose at 52.3 on foot of 52.7 in June. Which means profitability tanked.
• New export business indicator jumped to 55.7 in July from 54.2 in June, but this is hardly surprising, since the index has been showing robust expansion for 12 months now, following a surprise drop to 49.6 in July 2011. 12mo MA is at 53.2, 3mo average through July is at 54.2. These are really hardly credible numbers, or rather, these are the numbers showing that our Services sector exports have very little to do with employment or overall business activity in the sector itself. In other words, this shows that our services exports are as captive to MNCs as our manufacturing exports.
• Profitability - as measured by PMI (note, I produce my own metric, which will be reported later) - tanked again to 43.8 in July against 43.0 in June.

In the next couple of posts I will be covering combined results for Manufacturing and Services PMIs and a special note on Confidence metric - in honor of the KBC/ICA 'survey' results released yesterday.

3/8/2012: Did Draghi quietly score a policy coup d'etat?

Let me revisit yesterday's assessment of Mario Draghi's statements. With time passing, it is becoming clear that the key (only) tangible positive is Draghi's comment that he will focus on the shorter end of maturity curve and that this will be consistent with two things:

1. No commitment to sterilization, and
2. Commitment to targeting 'traditional monetary policy' objectives.

Let me explain why I now think these are significant game changers for ECB, and potentially, for euro area.

For some years, even before the financial crisis hit, the ECB (including Trichet before Draghi) have been focusing or attempting to focus policymakers' attention on the need for structural reforms. In the past this was accompanied with threats of tightening monetary policy. But now, such threats are clearly not credible. Hence, the ECB, to stay on the message that long-term structural reforms must be pursued needed to achieve the following objectives simultaneously:

• Reduce immediate pressure on funding indebted and deficit-laden peripherals (so reduce short-term borrowing rates)
• Increase long-term pressure on the peripherals to incentivise them pursue longer term reforms (so increase slope of the yield curve)
• Potentially support enhanced transmission of lower short-term rates into real economy (so alleviate pressure from sterilization of SMP), and lastly
• Reduce future problem of unwinding SMP-accumulated 'assets' off the ECB balancesheet

Now, what Draghi set out yesterday as a potential plan does appear to do all of the four things above. By focusing SMP on shorter term end of the yield curve, ECB will indeed lower shorter-term borrowing costs for Italy and Spain (3-5 year max maturity), while steepening 10 year instruments costs to discourage, relatively, longer term borrowings. This means Italy and Spain should get an added incentive - growing over time as overall maturity profile of their debt starts to shorten as well - to enact long-term reforms. At the same time, ECB will be buying (assuming it does go through with the threat) shorter-term instruments, implying that unwinding these assets will be a natural process of maturity. ECB will not commit to sacrificing long-term flexibility of its policy tools by expanding SMP on the longer end of the yield curve, thus reducing overall risks to the monetary policy in the future.

Some thoughts for the weekend, folks...