21/7/2014: Sources of FDI into Russia 2007-2013

An interesting chart: sources of FDI into Russia 2007-2013

Note the fifth in line: Ireland with major uplift in 2011-2013. Data is from the Central Bank of Russia.

Via @RencapMan

Update: via @QZ, a chart showing the opposite flows: Russian investments abroad:

21/7/2014: Why a Wave of Low-Pay Public Sector Jobs Applications?

Employment stats and claims have puzzled many in recent months. Government claimed variable numbers at different points in time, ranging between jobs created at 61,000 to 67,000 and so on. Much analysis has been provided of these claims and other numbers on this blog and many other, often divergent, often close-enough and so forth. All, however, points to the fact that jobs are being added in the economy and that at least some of the declines in unemployment rate are down to new positions being posted and filled.

Which raises a hugely surprising question: if private sectors jobs are being created, why is there such a huge surplus of unemployed applying for jobs in the private sector? Evidence of the latter is not systematic and not regular, but here is one snapshot: http://www.independent.ie/irish-news/news/28500-scramble-for-civil-service-jobs-at-11-an-hour-30444949.html

Note that the public sector jobs being rushed-at are not at the top or even the middle of pay & perks distribution. These are roughly EUR11/hour jobs, at the bottom of the career ladder and the recruits face the prospect of:

1. Higher taxes,
2. Lower non-wage benefits, 
3. Increased workloads (compared to the incumbents and past employees), and
4. Prospect of slower career progressions (early retirements took out a large share of senior employees and their positions are being filled internally, without any prospect of younger recruits qualifying for them).

One answer is that for all the changes in employment stats we had over the recent months, we still have huge levels of unemployment and underemployment as the legacy of the crisis. On underemployment side, take the percentages of workers in working less than full-time hours as a share of total employment pool. In Q1 2008, 7.5% of all workers in employment worked less than 20 hours/week, in Q1 2014 the percentage was 8.1%. Over the same period of time, % of workers working 20-29 hours per week rose from 10.9% to 12.8%, percentage working 30-34 hours per week rose from 4.3% to 4.5%. Percentage of workers working more than 35 hours per week dropped from 66.4% to 61.9%. Counting in those working less than full-time hours and those on variable hours, 38.1% of our employment pool are not in full-time employment against 33.6% back in Q1 2008. 

In Q1 2008, there were 113,600 individuals who considered themselves underemployed, in Q1 2014 the number was 258,100. And there are 46,500 more people who are working part-time and consider themselves underemployed today compared to Q3 2008 (earliest we have data for), while numbers of working-age adults not in the labour-force are still up 121,300 on Q1 2008.

And in the core age categories, applying for these jobs, the percentage of 15-24 year old unemployed relative to total population of that age group was 9.58% in Q1 2008. This stood at 25.31% in Q1 2014.

In other words, it is easy to forget that things are still very ugly when it comes to employment situation in Ireland.

21/7/2014: Russian Economy 1995-2008: Growth Drivers and Future Potential

Very insightful paper on Russian economic growth - sources and drivers - over the period of 1995-2008. "When high growth is not enough:
Rethinking Russia’s pre-crisis economic performance" by Ilya Voskoboynikov and Laura Solanko (BOFIT Policy Brief 6/2014: www.bof.fi/bofit_en) looks at the role of labour productivity, capital deepening and tech/multifactor productivity contributions to growth.

Here are some of the findings:

"The Russian economy experienced a long period of growth from the mid-1990s to the 2008 financial crisis with annual GDP per capita growth averaging 3.7 % between 1995 and 2008." So spectacular growth compared to pre-1995 period and this much is known.

"According to the prevailing narrative, this growth was mainly driven by sustained increases in multifactor productivity stemming from removal of distortions created under the planned Soviet economy."

But was it?

"Using newly available, internationally comparable, data and the growth accounting methodology of Timmer and Voskoboynikov (2014), we argue that average annual multifactor productivity growth amounted to 2.6% over the period. This remarkably high growth indicates that productivity growth accounted for about 56% of Russia’s economic growth in the 13 years before to the global financial crisis."

More: "We found that MFP growth explained over 70 % of total value-added growth in the period 1995–2001, but less than 50% in the 2003–2008 period. As the contribution of labor held relatively constant at around 10%, our finding implies that increases in capital inputs, and, consequently, investments to fixed capital, have been even more important than previously thought for economic growth in Russia."

Capital deepening and upgrades are the core drivers on both value added and productivity growth sides. What about sectoral decomposition?

"Detailed analysis of industry-level data reveals that economic growth has been driven by two broad sectors: extended oil & gas and high-skill-intensive (HSI) services."

Per oil & gas sector: "Our analysis clearly shows that growth in the extended oil & gas has been driven by increases in capital inputs, i.e. investments into fixed capital. Given the huge investments in oil and gas pipelines, oil export terminals, and the commissioning of new gas fields commissioned in past decade, we find this quite plausible."

On High-Skill-Intensive sectors side: "Since the end of our data sample in 2008, investment growth has slowed in the wake of the global financial crisis and increased uncertainly over the general business climate in Russia. The rapid growth in HIS services such as financial services largely represented a catching up with more advanced markets. The level of multifactor productivity in relation to German levels in the high-skill intensive sectors climbed from just 12% at the start of the observation period to almost 50% at the end."

Key conclusion: "Neither rapid growth in investment in the extended oil & gas sector nor rapid catching-up in technology intensive service industries is likely to spur Russia’s growth in the next decade. This underlines the urgency of identifying and exploiting new growth drivers for Russia."

I am not sure I agree. For a number of reasons:

1. MFP and capital productivity growth have been concentrated in high-skills services and energy sectors. Next, there is room for substantial modernisation of capital base one technological utilisation in other sectors. That is a major potential source for growth into the future decade or two.
2. Labour productivity growth has ben sluggish and lagging the MFP growth. This is primarily down to demographic effects, which are by now being extinguished. This opens up new frontiers for growth in labour productivity in all sectors of economy, but primarily in sectors other than high-skills services and energy.
3. Structural reforms, if enacted, can open up Russian markets as platforms for exports to the Eurasian Economic Union states - a potential that is already there and can be further enhanced with suitable reforms.

So even from the top-level view, there are at least three major growth drivers that are yet to be explored.

20/7/2014: The New Scariest Chart in Economics: June 2014 Update

Some time ago I started tracking the New Scariest Chart of the Crisis - the one plotting duration of unemployment in the U.S. and here is the latest monthly update:

Data on which the above is based is here:

Background to the chart is here: http://trueeconomics.blogspot.ie/2014/06/662014-king-of-scariest-charts-is-dead.html

19/7/2014: Trueconomics Cited in FT

Delighted and proud that FT is quoting the blog on European banks woes: http://www.ft.com/intl/cms/s/0/de39b744-0e61-11e4-a1ae-00144feabdc0.html#axzz37pQsLLmF

July 18, 2014 1:03 pm

Reality check for European banks

By Christopher Thompson and Andrew Bolger

Constantin Gurdgiev at True Economics says while current monetary and investment climates remain supportive of lower yields, markets are starting to show an increasing propensity to react strongly to negative newsflows. Investors’ view of the peripheral states as being strongly correlated in their performance remains in place, especially for Spanish, Portuguese and Greek sovereigns and corporate issuers.

“The markets are jittery and are getting trigger-happy on sell signals as strong rises in bond prices in recent months have resulted in sovereign and corporate debt being overbought by investors,” says Mr Gurdgiev.

Nice birthday present for myself. Thanks, FT!

19/7/2014: Irish Roads: Worse than Chile, better than Namibia?

So... after two decades of extensive road building on foot of EU and domestic money, Ireland's road system (based in a country with mild climate, no extreme temperatures variations and no seismic activities) is ranked right below that of Chile (seismically-active, extremely mountainous and extreme weather-impacted terrain) and one place above Namibia...

Source: http://www.bloomberg.com/quicktake/money-for-highways/

They should have tried parts of Sandymount and Ballsbridge where, despite the two areas being amongst the most exclusive real estate locations in the country, cars lose tyres and damage suspension on craters and poor pavement and worn-out speed bumps. Not that there is no such evidence across the entire country, of course...

19/7/2014: Some Early Signs of Crimean Economy Suffering Sustained Slowdown

A very interesting data coming out of Crimea - early indicators of the cost of Crimea's incorporation into Russia: http://www.infox.sg/others/frame/krym-prishel-v-upadok/

Roughly translating some parts of the article:

Tourism is suffering in Crimea - the sector is the cornerstone of the regional economy, but over the first 6 months of 2014, number of visitors to Crimea fell ca 29.5% y/y at 1,772,000 visitors as opposed to the same period of 2013 when Crimea received 2,515,000 visitors. The issue, of course, is not solely down to Crimea's accession to Russia - given the state of civil war in Ukraine and the collapse of the country economy, there can be expected a massive reduction in the number of travellers to all parts of Ukraine. Given recessionary dynamics in Russia, there also can be expected to be fewer tourists visiting all Black Sea resorts over this summer.

According to Ukrainian estimates, overall number of Ukrainians travelling to the Black Sea resorts (including those in Ukraine proper) is projected to fall by some 30% this year due to deepening economic crisis and falling real incomes.


The collapse of tourism to Crimea is probably a temporary phenomena. And much of it is due to disruptions in transport routes. For example, ferry crossings from Russian mainland rose 2.8 times, air traffic rose 1.6 times. However rail transport numbers fell 2.8 times. Rail goes via Ukrainian mainland, so this is not surprising. There is no land connection to Crimea from Russia and ferry and airlines capacities are very limited, although they will be expanded over time. The bridge, linking Crimea to Russian mainland will likely take 2 years to build and estimated costs range from USD2 to 4 billion.

As the result, at the start of the tourism season, Crimea's resorts reported 63% vacancy rates.

In the past, roughly two thirds of visitors to Crimea were Ukrainian nationals, with one third being Russian nationals. While the former are understandably cancelling their plans to vacation in Crimea, the latter are finding it difficult to get to the resorts: majority of Russian visitors in the past opted to travel either by car or by rail - both of these routes are now firmly blocked. Meanwhile, airports in Crimea are too small to accommodate significant numbers of visitors and their capacity is now already stretched to the limit. Two major carriers Transaero and Dobrolet are reporting 100% and 98-99% loads on their flights.

While much of this suggests that the problems with tourism sector are temporary, there are some worrying parallels across all sectors of Crimean economy. Apparently, lack of compliance with certification relating to EU requirement that any exports from Crimea can be accepted only if they bear certification from Ukraine, is reducing industrial output in Crimea. And European sanctions that ban exports from Crimea are hitting the sector hard. In the past, EU accounted for over 35% of total exports from Crimea. Now this is down to USD5.9 million and accounts for just 10.2% of total exports. Largest shares of exports to EU go to Germany (4.5%) and Hungary (2.1%), while Austria, France, Poland, the Netherlands and Lithuania accounted, jointly for 3.6%. Exports were heavily concentrated in industrial machinery, chemicals and agricultural goods. Meanwhile, shipments to Russia are rising, but slower than the decline is exports to EU.

Overall, the problems in tourism sector appear to be much more significant than in the industrial and agricultural sectors but these problems appear to be linked to:

1. Temporary transport links problems;
2. Decline in travel in Ukraine and Russia due to the economic slowdown; and
3. Much more longer term issue of Ukrainian tourists switching away from Crimea.

19/7/2014: Global Innovation Index 2014: Ireland vs 'Periphery'

In the previous post I gave detailed breakdown of Ireland's performance in Global Innovation Index 2014. I used small open economies and Switzerland (the world's highest ranked economy) as a reference group.

Here, primarily for the reason of convention, are the comparatives of Ireland's performance relative to the Euro area 'peripheral' states:

Clearly, Ireland is a much stronger performer in Innovation than all other 'peripheral' states. This is neither surprising nor unexpected. Crucially, the gap is wider today than in 2007-2008 and the gap is rather persistent over time. Average ex-Ireland 'peripheral' state rank was 34st in 2014 against Ireland's 11th, this is a very significant gap. This gap increased from 16-19 points on average for 2007-2010 period to 32 points in 2012 and 23 points in 2014.

Furthermore, it appears that even if we are to abstract away from the metrics very heavily influenced by the tax optimising MNCs, Ireland (under such a metric closer to 20th-23rd position in the World rankings) would still post a stronger performance than any other 'peripheral' state (best - Spain at 27th).

19/7/2014: Global Innovation Index 2014: Ireland's Performance

Global Innovation Index is out this week and the 2014 edition focus is on Human Capital (here) a topic close to my heart (see my TEDx talk on this here).

Here are some interesting comparatives taken over the Index history for Ireland and its core peers.

Firstly, in 2014, top 20 ranks are:

Ireland shows good performance, with 11th place in 2014, slightly down on 10th place in 2013 and significantly down on 7th place in 2012 rankings, but still better than historical average of 16th rank.

Here is evolution of Irish rankings over time, compared to other small open economies of Europe that rank in top 25 this year:

Not a bad performance for Ireland, I must say, though we should be aiming for a place in the top-10.

However, over longer time horizon our performance is second best in the group of peer economies:

The above chart highlights top 3 performers in terms of rankings dynamics (green bars) and worst 3 performers (red bars).

It is worth noting that Luxembourg is, in my view, an economy that simply should not be ranked due to massive distortions in its rankings induced by large share of the companies operating in the country only as post-box offices and due to huge proportion of its workforce not being residents of the country. In Ireland, there are some distortions as well, and these are very significant, but of magnitude they are much smaller than those in Luxembourg.

Here are some Ireland vs Switzerland comparatives in specific sub-indices:

Institutions:

The above shows relatively strong performance for Ireland, except for:

• Political Stability and Environment
• Government Effectiveness

Ireland leads Switzerland strongly on

• Business Environment metrics

Human Capital and Research:

Overall, we have a strong lead compared to Switzerland in:

• Education, when it comes to Spending on Education and on School Life Expectancy (so we spend more and our students stay in school longer, on average)
• Tertiary Enrolment (we have more student-age people in tertiary education)

We significantly lag Switzerland in:

• Tertiary Inbound Mobility (ability to attract students into Ireland)
• R&D
• Researchers
• Spending on R&D
• University Rankings (quality of education)

 Infrastructure:

We outperform Switzerland in nothing, save for GDP per unit of energy use, which is of course consistent with the fact that a larger share of our GDP accrues to tax optimisation than in the already low-tax Switzerland.

We lag Switzerland in everything else...

Market Sophistication:

We lead Switzerland in Credit, thanks to allegedly greater ease of getting credit in Ireland (I am not sure what the Index analysts mean by that, given that our credit supply is negative). Despite beating Swiss in 'credit' we lag them in Investment, which, presumably means that while we borrow more and easier, we do not invest what we borrow... may be it is because our businesses are buying BMWs and Mercs instead of machinery and technology? I have no idea...

Business Sophistication:

Remember that Ireland beats Switzerland on Ease of Doing Business. But with all that 'Ease' around, we are really not that far up on Switzerland in actual Business Sophistication... and if we strip out FDI inflows and imports of high tech equipment and inputs (a proxy for how many ICT MNCs we have 'operating' from here), we are probably actually ranked lower than Swiss.

Knowledge & Technology Outputs:

When it comes to actual Knowledge & Tech outputs, all of the above 'advantages' of Ireland over Switzerland vanish. Just as Savings vs Investments, we are good on inputs, but much less good on deriving anything meaningful from them. Control for tax optimisation activities of ICT services MNCs in Ireland and we sink even further below Switzerland.

Creative Outputs:

We are keen on painting Ireland as a Creative Land, while the Swiss are, as we often note, boring and 'Germanic' - aka not creative and too stringent. Right? Not really. Swiss beat us hands down on Creative Output metrics. We only outperform them in terms of Wikipedia edits and YouTube uploads - presumably due to the need to control our reputation by editing out unpleasant references to our social and industry and politics 'stars' from the public domain and down to our 'craic' in pubs and bars that get mistakenly posted on-line... I am, of course, being slightly sarcastic.

So net conclusions (on serious note):

1. We are getting better and are strong performers when it comes to many 'inputs' into Innovation; but
2. We are not that great in deriving 'outputs' from the 'inputs' we commit.
3. Much of the performance upside for Ireland is down to distortionary activities of a handful of MNCs trading from Ireland; and
4. Much of the performance downside for Ireland is down to indigenous activities of the rest of our economy.

18/7/2014: IMF Approves Ukrainian Funding... & Pushes the Country into Deeper Austerity

IMF Announced agreement with Ukraine on First Review under the Stand-By Arrangement. Comments in italics are mine.

Mr. Nikolay Gueorguiev, mission chief for Ukraine, made the following statement today in Kyiv: “The mission has reached understandings with the Ukrainian authorities on the policies necessary for the completion of the first review under the SBA… the authorities have committed to take a number of policy actions prior to the completion of the review. …The completion of the review would enable the disbursement of ...about US$1.4 billion. The mission found that policies have generally been implemented as planned and that all but one of the performance criteria for end-May have been met. All structural benchmarks for the first review have been met as well, although some of them with a delay. This is a notable achievement as the intensification of the conflict in the East means that the program has been implemented in an environment that is considerably more difficult than anticipated when it was launched."

It is worth noting that IMF generally does not lend to countries in a state of civil war or major insurgency. Presumably, when it does lend to such countries, the conditions for lending allow for the risk of acceleration of the conflict. It appears IMF is taken by the surprise by the continuation of the conflict and by amplification in both the Ukrainian Government offensive and the rebels' defensive stances:

“The conflict is putting increasing strain on the program [after just a MONTH of the programme existence?!] and a number of key elements of the macroeconomic framework have had to be revised: (i) economic prospects have deteriorated notably, and GDP is now expected to contract by 6.5 percent this year, compared to 5 percent when the program was adopted; (ii) a shortfall in revenue collections in the East, higher security spending, and lower-than-expected debt collection by Naftogaz will cause fiscal and quasi-fiscal deficits and financing needs to rise above the programmed path; and (iii) higher-than-expected capital outflows and monetization of fiscal deficits are causing pressures on net international reserves."

Ok, one can excuse IMF for missing the forecast, but points (ii) and (iii) risks were predictable and material even BEFORE the programme started. One has to wonder, did IMF extend funds under the assumptions that 

1. The conflict will somehow go away without major costs on the ground?
2. The Government will be able to engage in revenue collection in rebel-controlled areas?
3. Naftogaz will be able to do more successfully that which the Government is failing to do?
4. Capital outflows will be benign and monetization of fiscal deficits will not be aggressive to compensate for (1)-(3)?

Things get worse. “Notwithstanding the authorities' continued commitment to the program and good record of implementation so far, the authorities have decided to take a number of compensatory measures to limit the negative impact of the conflict in the short run, and ensure that key program objectives are achieved over the period of the two-year program".

This sounds actually fine, except when you start reading into what exactly the IMF prescribed for the authorities and what they did in the wake of this prescription:

• Point 1: "On fiscal policy, the authorities have decided to implement a package of revenue and expenditure measures, amounting to 1 percent of GDP in 2014, offsetting the effect of increased security spending by other expenditure cuts. They have also committed to limiting wage and pension increases to the level of inflation in 2015, continuing reform-based reduction in public sector employment, and exercising tight control over discretionary spending." Set aside the issue of 2015. Look at NOW. The country is in a civil war, it is facing into the prospect of medium-term rebuilding and peace-building. Government response: cut spending, increase allocation to defense. The latter is necessary, no doubt. But the former is simply inconsistent with the need to build peace and rebuild infrastructure and businesses and peoples' lives. De facto, IMF is pushing Ukraine into austerity just at the time as the country is going through a civil war! As a fiscal hawk, I have to ask if this is simply mad?
• Point 2: "In the energy sector, the authorities are taking additional actions to strengthen payment discipline and compliance, such as pursuing payments from collectible accounts and seizing assets if repayment is not forthcoming. They are also preparing to restructure Naftogaz with a view to improve the transparency of its operations and reduce costs." Should second take place before the first? Should Naftogaz be reformed to increase its legitimacy and democratic acceptance and only AFTER that should it pursue more aggressive collection? Remember, again, this is not a society with comfortable margins of income and security!
• Point 3: "The authorities are taking steps toward strengthening governance and improving the business climate. A recent diagnostic study has identified major areas for reforms. Based on the study’s recommendations the authorities plan to implement a wide range of anti-corruption measures, including establishment of an independent anti-corruption agency with broad investigative powers and adoption of legislative amendments to support the anti-corruption effort." This is an area where progress is necessary and vital. And it is good to see Ukrainian Government taking serious reps here, if only academic ones for now.

I will skip monetary policy points identified by the IMF - these are technical and, for now, theoretically supportive of the economy.

So two sets of 'compensatory' policies are de facto a road to disaster, one is the road toward potentially better future and one is technically supportive of the present. 

Still, the Fund is pleased: “On the strength of these compensatory measures and continued implementation of other policies agreed when the program was approved, staff is confident that the program can achieve its fundamental objectives of restoring internal and external macroeconomic equilibrium, generating sound and sustainable economic growth, and strengthening economic governance and transparency. In particular, while the combined fiscal and quasi fiscal deficits are projected to amount to 10.1 and 5.8 percent of GDP in 2014 and 2015, respectively—compared to previous targets of 8.5 and 6.1 percent—the structural adjustment is stronger by ½ percent of GDP over 2014-16 and the headline deficit will be below the originally programmed path by 2016. Similarly, gross reserves will be only some US$3.4 billion lower than programmed by end-2015. While external debt to GDP will peak 7 percentage points higher than programmed at end-2015, it will be on a steady downward slope by the end of the program, suggesting that external viability is not at risk." This is a bag full of estimates, assertions and forecasts. We know how these play out in reality even in countries not undergoing a civil war conflict.

But it gets better: “The program hinges crucially on the assumption that the conflict will begin to subside in the coming months." How many months? No idea. What happens in the post-conflict process? No idea. How much destruction will be brought about in resolving the conflict? No projections. Hope, hope and more IMF money… while Ukrainian people and State are doing all the heavy lifting.

I noted months ago that Ukraine will need a Marshall Plan, not an 'emergency liquidity support'. It still does - more than ever. This is not even being discussed.

17/7/2014: Irish Bilateral Trade in Goods with Russia & Ukraine

A journalist just requested from me some trade stats on Russian and Ukrainian trade with Ireland, so here is a summary table and a chart:

The table above shows irish exports to Russia by category. For comparison, Ukraine:

And totals for 2012-2013 full year:

Russia dwarfs Ukraine as trading partner for Ireland by:

• Exports - 2012-2013 average levels of goods exports to Russia is at EUR620 million against those to Ukraine at EUR62.2 million.
• Trade balance: average 2012-2013 goods trade balance wit Russia is at +EUR151.5 million surplus against deficit of -EUR16 million for Ukraine.
• In trade flows for the first four months of 2014
• Indigenous exports component of our trade: approximately 40-42% of our trade with Russia related to indigenous sectors of the economy, as opposed to near zero for our exports to Ukraine.

17/7/2014: More Russia Sanctions, Same Pains, Same Strategies

Another set of sanctions and another tumble in Russian shares. This time around, sanctions have impacted major Russian companies with significant ties to the global economy. However, no broad sectoral sanctions were introduced.

The following companies are hit:

• Rosneft - largest oil producer in Russia
• Gazprombank - largest bank in Russia outside retail sector
• VEB - Vnesheconombank 
• Novatek - largest independent natural gas producer
• Federal State Unitary Enterprise State Research And Production Enterprise Bazalt, 
• Feodosia Oil Products Supply Company (in Crimea)
• Radio-Electronic Technologies Concern KRET 
• Concern Sozvezdie
• Military-Industrial Corporation NPO Mashinostroyenia  
• Defense Consortium Almaz-Antey
• Kalashnikov Concern
• KBP Instrument Design Bureau
• Research and Production Corporation Uralvagonzavod 

Full list here: http://www.treasury.gov/ofac/downloads/ssinew14.pdf

The U.S. Treasury Department said that under new sanctions, the U.S. companies are only prohibited from dealing in "new debt of longer than 90 days maturity or new equity" with the listed non-defence firms. There are no asset freezes, no prohibitions or restrictions on export/import transactions. The sanctions do not impact U.S. and other multinationals' work in Russia, unless Moscow retaliates with such measures (which is unlikely).

This contrasts with previous sanctions under which sanctioned companies were prevented from conducting any transactions, including export/import and clearing with the U.S. firms.

So we are having a clear attempt to undercut some Russian companies' access to the U.S. debt and equity markets, while preserving their ability to trade.

VEB will unlikely feel the pinch. The bank converted the National Wealth Fund deposits into capital recently, so it can offset the shortfall on foreign funding.

Gazprombank is a different issue. Last month, Gazprombank raised EUR1 billion at 4% pa in the foreign markets via a bond sale on the Irish Stock Exchange. Gazprombank has one of the largest exposures to international funding markets of all other Russian financial institutions - it has 78 outstanding eurobond issues demented in a number of currencies. So the real problem with the sanctions is that they may open the way for EU to follow, which can shut Gazprombank from the Euro-denominated debt markets too.

When it comes to Rosneft, sanctions are weak. The U.S. simply cannot afford shutting flows of Russian gas and oil to global markets. Reason? Imagine what oil price will be at, if Rosneft was restricted from trading. The company is responsible for roughly 40% of the total Russian oil production which runs at around 10.5-10.9 million barrels per day. Get Rosneft supply access cut and you have an equivalent of entire Iraq's 2013 output (that's right - total output of Iraq is lower than that of Rosneft alone) drained from the global production. Rosneft pumps more oil than Canada and more than double the output of Norway.

You can read on geopolitics of Russian oil & gas here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html

The real target of the sanctions are pre-paid contracts that Rosneft and Novatek have on future supplies of oil and gas. These are de facto forward loans, repayable with future oil and gas supplies. Rosneft exposure to these currently sits at around USD15 billion. Another target: long term funding for energy companies. Rosneft raised USD30 billion in two loans in 2012 and 2013, in part to co-fund buyout of TNK-BP which cost Rosneft USD55 billion in 2013.

In reality, while short- and medium-term borrowing costs for two Russian energy companies is likely to rise, the effect in the longer term will be to push more and more trade and finance away from the U.S. dollar and U.S. markets. Plenty of potential substitutes are open: Hong Kong and Singapore being the most obvious ones. London is a less likely target. For example, in June partially state-owned UK Lloyds Bank cancelled a USD2 billion prepayment facility with Rosneft. The loser is, of course, Lloyds as it foregoes substantial revenues, while Rosneft can secure (albeit also at a price) similar funding from any number of larger trading companies it deals with, e.g. Glencore, Vitol or Trafigura.

Bloomberg covers some of the immediate reactions in corporate debt markets here: http://www.bloomberg.com/news/2014-07-17/rosneft-bonds-sink-most-on-record-as-sanctions-shut-debt-markets.html

All in, there is still ca USD60 billion worth of maturing corporate debt that Russian companies need to roll over before the end of 2014. This is a bit of a tight spot for Russian economy going forward, but it can be offset by releasing some of the liquidity accumulated on Russian banks balance sheets in 2013.


There is a bit of a silver lining for Russia from the U.S. sanctions too. To-date, higher oil prices worldwide (primarily driven by the Middle East mess, but now also with a support from the latest Russia sanctions) pushed up Federal Budget surplus to 1.4% of GDP (see latest arithmetic here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html) over January-May 2014. This means Moscow can afford a bit more of a stimulus this year, offsetting any sanctions-related adverse effects on its economy in the short run.

On another positive side, sanctions have triggered renewed interest in Moscow in developing domestic enterprises with a view of creating a buffer for imports risks (http://en.itar-tass.com/world/741073). Imports substitution is a norm for Russian economy during strong devaluations of the ruble. This time around, we can expect a push toward more domestic investment and enterprise development to drive imports substitution growth to compensate not for Forex changes, but for the risks of deeper and broader sanctions in the future.


So I would re-iterate my previously made call: 

1. Russian economy is in a short- medium-term decline in terms of growth
2. Growth slowdown is compounded by rising borrowing costs and adverse news flow
3. With correct course of actions (monetary & fiscal policies and potentially some regulatory changes), Moscow can steer the economy into recovery in 2015
4. Ukraine crisis abating during the rest of 2014 is likely to support (3) above

All of the above suggest the markets will be oversold by the time Russian equities corrections hit 8-10% mark, assuming, of course, no further escalation in Ukraine (both with and without Russian influence, Ukraine's internal problems have now been firmly pushed by the EU into Russian domain).

There has been no cardinal change in the Western strategy with respect to Ukraine (support at any cost of Poroshenko push East) and with respect to Russia (blame at any opportunity for anything happening in Ukraine). The latest sanctions are simply a replay of the previous ones, which means that the U.S. is relatively satisfied with the progress in Ukraine, while the EU has moved to the back seat, having finalised the association agreement and unwilling to expand on this.


As a side note: there are implications building up for Western companies, relating to the U.S. and EU sanctions:

• Bloomberg reports (http://www.bloomberg.com/news/2014-07-16/as-ukraine-heats-up-exxon-to-airbus-eye-growing-risks.html) on Exxon Mobil Corp, Airbus Group NV and Daimler AG risks;
• ITAR-Tass covers the cases of Caterpillar and Bombardier: http://en.itar-tass.com/world/741083

On political front, here is an interesting report on President Putin approval ratings: http://en.itar-tass.com/russia/740817. I have not seen the original study cited in the report, yet.